AIG 2007 Annual Report Download - page 160

American International Group, Inc. and Subsidiaries
Management’s Discussion and Analysis of
Financial Condition and Results of Operations Continued
maximum allowable percentage under current local regulation. The
Life Insurance & Retirement Services Invested
majority of Nan Shan’s in-force policy portfolio is traditional life
Assets
and endowment insurance products with implicit interest rate
guarantees. New business with lower interest rate guarantees are
With respect to Life Insurance & Retirement Services, AIG uses
gradually reducing the overall interest requirements, but asset
asset-liability management as a tool worldwide in the life insur-
portfolio yields have declined faster due to the prolonged low
ance business to influence the composition of the invested assets
interest rate environment. As a result, although the investment
and appropriate marketing strategies. AIG’s objective is to
margins for a large block of in-force policies are negative, the
maintain a matched asset-liability structure. However, in certain
block remains profitable overall because the mortality and
markets, the absence of long-dated fixed income investment
expense margins presently exceed the negative investment
instruments may preclude a matched asset-liability position. In
spread. In response to the low interest rate environment and the
addition, AIG may occasionally determine that it is economically
volatile exchange rate of the Taiwanese dollar, Nan Shan is
advantageous to be temporarily in an unmatched position. To the
emphasizing new products with lower implied guarantees, includ-
extent that AIG has maintained a matched asset-liability structure,
ing participating endowments and investment-linked products.
the economic effect of interest rate fluctuations is partially
Although the risks of a continued low interest rate environment
mitigated.
coupled with a volatile Taiwanese dollar could increase net
AIG’s investment strategy for the Life Insurance & Retirement
liabilities and require additional capital to maintain adequate local
Services segment is to produce cash flows greater than maturing
solvency margins, Nan Shan currently believes it has adequate
insurance liabilities. AIG actively manages the asset-liability rela-
resources to meet all future policy obligations.
tionship in its foreign operations, even though certain territories
AIG actively manages the asset-liability relationship in its
lack qualified long-term investments or certain local regulatory
domestic operations. This relationship is more easily managed
authorities may impose investment restrictions. For example, in
through the availability of qualified long-term investments.
several Southeast Asian countries, the duration of investments is
A number of guaranteed benefits, such as living benefits or
shorter than the effective maturity of the related policy liabilities.
guaranteed minimum death benefits, are offered on certain
Therefore, there is risk that the reinvestment of the proceeds at
variable life and variable annuity products. AIG manages its
the maturity of the initial investments may be at a yield below that
exposure resulting from these long-term guarantees through
of the interest required for the accretion of the policy liabilities.
reinsurance or capital market hedging instruments.
Additionally, there exists a future investment risk associated with
AIG invests in equities for various reasons, including diversify-
certain policies currently in-force which will have premium receipts
ing its overall exposure to interest rate risk. Available for sale
in the future. That is, the investment of these future premium
bonds and equity securities are subject to declines in fair value.
receipts may be at a yield below that required to meet future
Such declines in fair value are presented in unrealized apprecia-
policy liabilities.
tion or depreciation of investments, net of taxes, as a component
AIG actively manages the interest rate assumptions and
of Accumulated other comprehensive income. Declines that are
crediting rates used for its new and in force business. Business
determined to be other-than-temporary are reflected in income in
strategies continue to evolve to maintain profitability of the overall
the period in which the intent to hold the securities to recovery no
business. In some countries, new products are being introduced
longer exists. See Valuation of Invested Assets herein. Generally,
with minimal investment guarantees, resulting in a shift toward
insurance regulations restrict the types of assets in which an
investment-linked savings products and away from traditional
insurance company may invest. When permitted by regulatory
savings products with higher guarantees.
authorities and when deemed necessary to protect insurance
The investment of insurance cash flows and reinvestment of
assets, including invested assets, from adverse movements in
the proceeds of matured securities and coupons requires active
foreign currency exchange rates, interest rates and equity prices,
management of investment yields while maintaining satisfactory
AIG and its insurance subsidiaries may enter into derivative
investment quality and liquidity.
transactions as end users to hedge their exposures. For a further
AIG may use alternative investments, including equities, real
discussion of AIG’s use of derivatives, see Risk Management —
estate and foreign currency denominated fixed income instru-
Credit Risk Management — Derivatives herein.
ments in certain foreign jurisdictions where interest rates remain
In certain jurisdictions, significant regulatory and/or foreign
low and there are limited long-dated bond markets to extend the
governmental barriers exist which may not permit the immediate
duration or increase the yield of the investment portfolio to more
free flow of funds between insurance subsidiaries or from the
closely match the requirements of the policyholder liabilities and
insurance subsidiaries to AIG parent. For a discussion of these
DAC recoverability. This strategy has been effectively used in
restrictions, see Item 1. Business — Regulation.
Japan and more recently by Nan Shan in Taiwan. In Japan, foreign
Life Insurance & Retirement Services invested assets grew by
assets, excluding those matched to foreign liabilities, were
$41.7 billion, or 10 percent, during 2007 as bond holdings grew
approximately 31 percent of statutory assets, which is below the
by $5.3 billion, and listed equity holdings grew by $9.3 billion, or
maximum allowable percentage under current local regulation.
39 percent.
Foreign assets comprised approximately 33 percent of Nan
Shan’s invested assets at December 31, 2007, slightly below the
106 AIG 2007 Form 10-K