AIG 2006 Annual Report Download - page 80

American International Group, Inc. and Subsidiaries
Management’s Discussion and Analysis of
Financial Condition and Results of Operations Continued
period are not unusual because of the transaction-oriented nature Critical Accounting Estimates
of Capital Markets operations. AIG considers its most critical accounting estimates to be those
relating to reserves for losses and loss expenses, future policy
Asset Management benefits for life and accident and health contracts, recoverability
AIG’s Asset Management operations include institutional and retail of DAC, estimated gross profits for investment-oriented products,
asset management, broker-dealer services and institutional fair value determinations for certain Capital Markets assets and
spread-based investment businesses. The MIP has replaced the liabilities, other-than-temporary declines in the value of invest-
GIC program as AIG’s principal spread-based investment activity. ments and flight equipment recoverability. These accounting
Asset Management operating income increased 4 percent in estimates require the use of assumptions about matters, some of
2006 compared to 2005 due primarily to growth in asset which are highly uncertain at the time of estimation. To the extent
management fees within Institutional Asset Management and actual experience differs from the assumptions used, AIG’s
income from the MIP. These increases were partially offset by the results of operations would be directly affected.
continued runoff of GIC balances, spread compression in the Throughout this Management’s Discussion and Analysis of
remaining GIC portfolio as well as decreased performance-based Financial Condition and Results of Operations, AIG’s critical
fees. Gains and losses arising from the consolidation of certain accounting estimates are discussed in detail. The major catego-
variable interest entities (VIEs) and partnerships are included in ries for which assumptions are developed and used to establish
operating income, but are offset in minority interest expense, each critical accounting estimate are highlighted below. For a
which is not a component of operating income. discussion regarding the significant accounting policies relating to
these estimates, see Note 1 of Notes to Consolidated Financial
Capital Resources Statements.
At December 31, 2006, AIG had total consolidated shareholders’ Reserves for Losses and Loss Expenses (General Insurance):
equity of $101.68 billion and total consolidated borrowings of
(Loss trend factors: used to establish expected loss ratios for
$148.68 billion. At that date, $131.55 billion of such borrowings
subsequent accident years based on premium rate adequacy
were not guaranteed by AIG, were matched borrowings by AIG or
and the projected loss ratio with respect to prior accident
AIGFP, or represented liabilities connected to trust preferred
years.
stock.
(Expected loss ratios for the latest accident year: in this case,
AIG did not purchase shares of its common stock under its
accident year 2006 for the year end 2006 loss reserve
common stock repurchase authorization during 2006. In February
analysis. For low-frequency, high-severity classes such as
2007, AIG’s Board of Directors increased the repurchase program
excess casualty, expected loss ratios generally are utilized for
by authorizing the repurchase of shares with an aggregate
at least the three most recent accident years.
purchase price of $8 billion.
(Loss development factors: used to project the reported losses
In 2007, AIG expects to issue capital securities in one or more
for each accident year to an ultimate amount.
series. The proceeds will be used to repurchase shares of
(Reinsurance recoverable on unpaid losses: the expected recov-
common stock or to otherwise improve the efficiency of AIG’s
eries from reinsurers on losses that have not yet been
capital structure.
reported and/or settled.
Liquidity
Future Policy Benefits for Life and Accident and Health Contracts
AIG manages liquidity at both the subsidiary and parent company (Life Insurance & Retirement Services):
levels. At December 31, 2006, AIG’s consolidated invested
(Interest rates: which vary by geographical region, year of
assets, primarily held by its subsidiaries, included $26.8 billion in issuance and products.
cash and short-term investments. Consolidated net cash provided
(Mortality, morbidity and surrender rates: based upon actual
from operating activities in 2006 amounted to $6.8 billion. At the experience by geographical region modified to allow for variation
parent company level, liquidity management activities are con- in policy form, risk classification and distribution channel.
ducted in a manner to preserve and enhance funding stability,
flexibility, and diversity through the full range of potential operating Estimated Gross Profits (Life Insurance & Retirement Services):
environments and market conditions. AIG’s primary sources of
(Estimated gross profits: to be realized over the estimated
cash flow are dividends and other payments from its regulated
duration of the contracts (investment-oriented products) affect
and unregulated subsidiaries, as well as issuances of debt
the carrying value of DAC, unearned revenue liability and
securities. Primary uses of cash flow are for debt service,
associated amortization patterns under FAS 97 and Sales
subsidiary funding and shareholder dividend payments. Manage-
Inducement Assets under SOP 03-1. Estimated gross profits
ment believes that AIG’s liquid assets, cash provided by opera-
include investment income and gains and losses on invest-
tions and access to the capital markets will enable it to meet its
ments less required interest, actual mortality and other
anticipated cash requirements, including the funding of increased
expenses.
dividends under AIG’s new dividend policy and repurchases of
common stock.
30 AIG 2006 Form 10-K