AIG 2006 Annual Report Download - page 65

American International Group, Inc. and Subsidiaries
accelerate its DAC amortization and such acceleration could
Item 1A.
adversely affect AIG’s results of operations. See also Manage-
Risk Factors
ment’s Discussion and Analysis of Financial Condition and Results
Casualty Insurance Underwriting and Reserves of Operations — Critical Accounting Estimates and Notes 1 and 4
of Notes to Consolidated Financial Statements.
Casualty insurance liabilities are difficult to predict and may
exceed the related reserves for losses and loss expenses. Reinsurance
Although AIG annually reviews the adequacy of the established
reserve for losses and loss expenses, there can be no assurance Reinsurance may not be available or affordable. AIG subsidiaries
that AIG’s ultimate loss reserves will not develop adversely and are major purchasers of reinsurance and utilize reinsurance as
materially exceed AIG’s current loss reserves. Estimation of part of AIG’s overall risk management strategy. Reinsurance is an
ultimate net losses, loss expenses and loss reserves is a important risk management tool to manage transaction and
complex process for long-tail casualty lines of business, which insurance line risk retention, and to mitigate losses that may arise
include excess and umbrella liability, D&O, professional liability, from catastrophes. Market conditions beyond AIG’s control deter-
medical malpractice, workers compensation, general liability, mine the availability and cost of the reinsurance purchased by AIG
products liability and related classes, as well as for asbestos and subsidiaries. For example, reinsurance may be more difficult to
environmental exposures. Generally, actual historical loss develop- obtain after a year with a large number of major catastrophes.
ment factors are used to project future loss development. Accordingly, AIG may be forced to incur additional expenses for
However, there can be no assurance that future loss development reinsurance or may be unable to obtain sufficient reinsurance on
patterns will be the same as in the past. Moreover, any deviation acceptable terms, in which case AIG would have to accept an
in loss cost trends or in loss development factors might not be increase in exposure risk, reduce the amount of business written
discernible for an extended period of time subsequent to the by its subsidiaries or seek alternatives.
recording of the initial loss reserve estimates for any accident
Reinsurance subjects AIG to the credit risk of its reinsurers and
year. Thus, there is the potential for reserves with respect to a
may not be adequate to protect AIG against losses. Although
number of years to be significantly affected by changes in loss
reinsurance makes the reinsurer liable to the AIG subsidiary to
cost trends or loss development factors that were relied upon in
the extent the risk is ceded, it does not relieve the AIG subsidiary
setting the reserves. These changes in loss cost trends or loss
of the primary liability to its policyholders. Accordingly, AIG bears
development factors could be attributable to changes in inflation
credit risk with respect to its subsidiaries’ reinsurers. A rein-
or in the judicial environment, or in other social or economic
surer’s insolvency or inability or refusal to make timely payments
phenomena affecting claims. See also Management’s Discussion
under the terms of its agreements with the AIG subsidiaries could
and Analysis of Financial Condition and Results of Operations —
have a material adverse effect on AIG’s results of operations and
Operating Review — General Insurance Operations — Reserve for
liquidity. See also Management’s Discussion and Analysis of
Losses and Loss Expenses.
Financial Condition and Results of Operations — Risk Manage-
ment — Reinsurance.
Adjustments to Life Insurance & Retirement
Services Deferred Policy A Material Weakness
Acquisition Costs
The remaining material weakness in AIG’s internal control over
Interest rate fluctuations and other events may require AIG
financial reporting relating to income tax accounting could
subsidiaries to accelerate the amortization of deferred policy
affect the accuracy or timing of future regulatory filings. As of
acquisition costs (DAC) which could adversely affect AIG’s
December 31, 2006, AIG’s management concluded that the
consolidated financial condition or results of operations. DAC
material weakness relating to the controls over income tax
represents the costs that vary with and are related primarily to
accounting was not fully remediated. Remediation of this material
the acquisition of new and renewal insurance and annuity
weakness is ongoing. Until remediated, this weakness could
contracts. When interest rates rise, policy loans and surrenders
affect the accuracy or timing of future filings with the SEC and
and withdrawals of life insurance policies and annuity contracts
other regulatory authorities. See also Item 9A. Controls and
may increase as policyholders seek to buy products with per-
Procedures — Management’s Report on Internal Control Over
ceived higher returns, requiring AIG subsidiaries to accelerate the
Financial Reporting.
amortization of DAC. To the extent such amortization exceeds
surrender or other charges earned upon surrender and withdraw- Catastrophe Exposures
als of certain life insurance policies and annuity contracts, AIG’s
results of operations could be negatively affected. The occurrence of catastrophic events could adversely affect
DAC for both insurance-oriented and investment-oriented prod- AIG’s consolidated financial condition or results of operations.
ucts as well as retirement services products is reviewed for The occurrence of events such as hurricanes, earthquakes,
recoverability, which involves estimating the future profitability of pandemic disease, acts of terrorism and other catastrophes could
current business. This review involves significant management adversely affect AIG’s consolidated financial condition or results of
judgment. If the actual emergence of future profitability were to be
substantially lower than estimated, AIG could be required to
Form 10-K 2006 AIG 15