AIG 2007 Annual Report Download - page 132

American International Group, Inc. and Subsidiaries
Management’s Discussion and Analysis of
Financial Condition and Results of Operations Continued
comprehensive income until the bond is sold or deemed to be Deferred Policy Acquisition Costs and Sales Inducement
other-than-temporarily impaired. Assets
For the Domestic Life Insurance and Domestic Retirement DAC for Life Insurance & Retirement Services products arises
Services operations, the higher net realized capital losses from the deferral of costs that vary with, and are directly related
resulted principally from other-than-temporary impairment charges to, the acquisition of new or renewal business. Policy acquisition
of $1.8 billion in 2007 compared to $560 million in 2006 and costs for life insurance products are generally deferred and
from the sale of securities in 2007 to reposition assets in certain amortized over the premium paying period in accordance with
investment portfolios. Net realized capital losses in the Domestic FAS 60. Policy acquisition costs that relate to universal life and
Life Insurance operations in 2007 included losses of $186 million investment-type products are deferred and amortized, with interest
related to derivatives that did not qualify for hedge accounting in relation to the incidence of estimated gross profits to be
treatment under FAS 133 compared to a gain of $25 million in realized over the estimated lives of the contracts in accordance
2006. Derivatives in the Domestic Life Insurance operations with FAS 97. Value of Business Acquired (VOBA) is determined at
include affiliated interest rate swaps used to economically hedge the time of acquisition and is reported on the consolidated
cash flows on bonds and option contracts used to economically balance sheet with DAC and amortized over the life of the
hedge cash flows on indexed annuity and universal life products. business, similar to DAC. AIG offers sales inducements to
The corresponding gain or loss with respect to the economically contract holders (bonus interest) on certain annuity and invest-
hedged bond is deferred in accumulated other comprehensive ment contracts. Sales inducements are recognized as part of the
income until the bond is sold, matures or deemed to be other- liability for policyholders contract deposits on the consolidated
than-temporarily impaired. See Invested Assets — Valuation of balance sheet and are amortized over the life of the contract
Invested Assets — Portfolio Review herein. similar to DAC. Total deferred acquisition and sales inducement
costs increased $549 million in 2007 compared to 2006 primarily
2006 and 2005 Comparison due to higher production in the Foreign Life Insurance operations
Net realized capital gains (losses) in 2006 improved $246 million partially offset by lower Domestic Life Insurance & Retirement
compared to 2005 primarily due to gains on derivative instru- Services sales. Total amortization expense decreased $328 mil-
ments primarily used to economically hedge cash flows that did lion compared to 2006. Annualized amortization expense levels in
not qualify for hedge accounting treatment under FAS 133 and 2007 and 2006 were approximately 10 percent and 13 percent,
related primarily to the Foreign Life Insurance & Retirement respectively, of the opening DAC balance. The decline in amor tiza-
Services operations. tion expense levels relates to changes in actuarial estimates,
which is substantially offset by related adjustments to incurred
policy losses and benefits.
78 AIG 2007 Form 10-K