AIG 2006 Annual Report Download - page 97

American International Group, Inc. and Subsidiaries
D&O and Related Management Liability Classes of Business: For trend could vary significantly from this assumption, and there can
D&O and related management liability classes of business, the be no assurance that actual loss costs will not deviate, perhaps
assumed loss cost trend was approximately four percent. After materially, by greater than five percent.
evaluating the historical loss cost trends from prior accident years For excess workers compensation business, the assumed loss
since the early 1990s, in AIG’s judgment, it is reasonably likely development factors are a critical assumption. Excess workers
that actual loss cost trends applicable to the year-end 2006 loss compensation is an extremely long-tail class of business, with a
reserve review for these classes will range from negative much greater than normal uncertainty as to the appropriate loss
11 percent to positive 19 percent, or approximately 15 percent development factors for the tail of the loss development. After
lower or higher than the assumption actually utilized in the year- evaluating the historical loss development factors for prior
end 2006 reserve review. A 15 percent change in the assumed accident years since the 1980s, in AIG’s judgment, it is
loss cost trend for these classes would cause approximately a reasonably likely that actual loss development factors will range
$625 million increase or a $550 million decrease in the net loss approximately 15 percent lower or higher than those factors
and loss expense reserves for these classes of business. It actually utilized in the year-end 2006 loss reserve review for
should be emphasized that the 15 percent deviations are not excess workers compensation. If the loss development factor
considered the highest possible deviations that might be ex- assumptions were changed by 15 percent, the net loss reserves
pected, but rather what is considered by AIG to reflect a for excess workers compensation would increase or decrease by
reasonably likely range of potential deviation. Actual loss cost approximately $600 million. Given the exceptionally long-tail for
trends for these classes in the early 1990s were negative for this class of business, there is the potential for actual deviations
several years, including amounts below the negative 11 percent in the loss development tail to exceed the deviations assumed,
cited above, whereas actual loss cost trends in the late 1990s perhaps materially.
ran at nearly 50 percent per year for several years, vastly Primary Workers Compensation: For primary workers compensa-
exceeding the 19 percent figure cited above. Because the D&O tion, the loss cost trend assumption is not believed to be material
class of business has exhibited highly volatile loss trends from with respect to AIG’s loss reserves. This is primarily because
one accident year to the next, there is the possibility of an AIG’s actuaries are generally able to use loss development
exceptionally high deviation. projections for all but the most recent accident year’s reserves,
For D&O and related management liability classes of business, so there is limited need to rely on loss cost trend assumptions for
the assumed loss development factors are also an important primary workers compensation business.
assumption but less critical than for excess casualty. Because However, for primary workers compensation business the loss
these classes are written on a claims made basis, the loss development factor assumptions are important. Generally, AIG’s
reporting and development tail is much shorter than for excess actual historical workers compensation loss development factors
casualty. However, the high severity nature of the claims does would be expected to provide a reasonably accurate predictor of
create the potential for significant deviations in loss development future loss development. However, workers compensation is a
patterns from one year to the next. After evaluating the historical long-tail class of business, and AIG’s business reflects a very
loss development factors for these classes of business for significant volume of losses particularly in recent accident years
accident years since the early 1990s, in AIG’s judgment, it is due to growth of the business. After evaluating the actual
reasonably likely that actual loss development factors will range historical loss developments since the 1980s for this business, in
approximately five percent lower or higher than those factors AIG’s judgment, it is reasonably likely that actual loss develop-
actually utilized in the year-end 2006 loss reserve review for these ment factors will fall within the range of approximately 2.75 per-
classes. If the loss development factor assumptions were cent below to 7.5 percent above those actually utilized in the year-
changed by five percent, the net loss reserves for these classes end 2006 loss reserve review. If the loss development factor
would be estimated to increase or decrease by approximately assumptions were changed by 2.75 percent and 7.5 percent,
$200 million. As noted above for excess casualty, actual historical respectively, the net loss reserves for workers compensation
loss development factors are generally used to project future loss would decrease or increase by approximately $525 million and
development. However, there can be no assurance that future $1.5 billion, respectively. It should be noted that loss emergence
loss development patterns will be the same as in the past, or that in 2006 for this class was higher than historical averages,
they will not deviate by more than the five percent. resulting in an increase in loss reserves for prior accident years.
Excess Workers Compensation: For excess workers compensation However, it is too soon to ascertain if this increased emergence
business, loss costs were trended at six percent per annum. After represents a new trend in the pattern of loss development. For
reviewing actual industry loss trends for the past ten years, in this class of business, there can be no assurance that actual
AIG’s judgment, it is reasonably likely that actual loss cost trends deviations from the expected loss development factors will not
applicable to the year-end 2006 loss reserve review for excess exceed the deviations assumed, perhaps materially.
workers compensation will range five percent lower or higher than Other Casualty Classes of Business: For casualty business other
this estimated loss trend. A five percent change in the assumed than the classes discussed above, there is generally some
loss cost trend would cause approximately a $350 million potential for deviation in both the loss cost trend and loss
increase or a $225 million decrease in the net loss reserves for development factor assumptions. However, the effect of such
this business. It should be emphasized that the actual loss cost
Form 10-K 2006 AIG 47