AIG 2008 Annual Report Download - page 83

in 2007 was 0.9 points lower than the loss ratio recorded in 2006 for accident year 2006. The loss ratio for accident
year 2006 has improved in each quarter since September 30, 2006. As a result, the 2007 accident year loss ratio is
2.8 points higher than the 2006 accident year loss ratio, reflecting reductions in 2006 accident year losses recorded
through December 31, 2007. Prior year development reduced incurred losses by $390 million in 2007 and increased
incurred losses by $175 million in 2006, accounting for 2.4 points of the improvement in the loss ratio.
Commercial Insurance expense ratio decreased to 18.4 in 2007 compared to 20.1 in 2006, primarily due to the
2006 charge related to the remediation of the material weakness in internal control over certain balance sheet
reconciliations that accounted for 2.1 points of the decline. The decline was partially offset by increases in operating
expenses for marketing initiatives and operations.
Mortgage Guaranty Results
2008 and 2007 Comparison
Mortgage Guaranty operating loss increased in 2008 compared to 2007 due to declining housing values,
increasing mortgage foreclosures and the recognition of a premium deficiency reserve on the second-lien business.
The domestic first-lien operating loss increased by $1.0 billion in 2008 to $1.1 billion compared to 2007 while the
second-lien operating loss of $1.2 billion in 2008, which includes the recognition of a $222 million premium
deficiency reserve, increased $656 million compared to 2007.
During 2008, UGC tightened underwriting standards and increased premium rates for its first-lien business and
ceased insuring second-lien business as of September 30, 2008. During the fourth quarter of 2008, UGC ceased
insuring new private student loan business and suspended insuring new business throughout its European
operations. All of these actions were in response to the deteriorating market conditions and resulted in a significant
decline in new business written during the second half of 2008.
Net premiums written declined in 2008 compared to 2007. First- and second-lien business net premiums
written grew moderately, primarily due to increased persistency year over year. However, new insurance written,
which is a measure of the amount of new insurance added to the portfolio, decreased 45 percent, 82 percent and
42 percent for first- and second-lien business and international business, respectively, during 2008 compared to
2007. These declines are primarily due to UGC’s tightening of underwriting guidelines and rate increases during the
year and the actions described above.
Claims and claims adjustment expenses increased $1.8 billion compared to 2007 primarily due to the
continuing decline in the domestic housing market. Domestic first-lien losses incurred of $1.8 billion increased
159 percent compared to the same period in 2007 resulting in a 2008 first-lien loss ratio of 276 compared to a 2007
loss ratio of 122. Second-lien losses incurred of $1.2 billion increased 61 percent compared to the same period in
2007. UGC strengthened international loss reserves by $96 million during the fourth quarter of 2008. Increases in
both domestic and international losses incurred resulted in an overall loss ratio for Mortgage Guaranty (excluding
the second-lien business in run-off) of 257 in 2008 compared to 111 in 2007. UGC’s ability to cede losses to captive
insurers will be reduced in future periods primarily due to captive reinsurers exceeding the limits of the reinsurance
agreements.
Historically, Mortgage Guaranty included all mortgage insurance risks in a single premium deficiency test
because the manner of acquiring, servicing and measuring the profitability of all Mortgage Guaranty contracts was
consistent. Due to the run-off in the second-lien business, management no longer measures the profitability for the
second-lien business in the same manner as that for Mortgage Guaranty’s ongoing businesses, and will no longer
report loss ratio or expense ratio information for the second-lien business. As a result, UGC performs a separate
premium deficiency calculation for the second-lien business.
At December 31, 2008, the present value of expected second-lien future losses and expenses (net of expected
future recoveries) was $1.4 billion, and was offset by the present value of expected second-lien future premiums of
$499 million and the already established liability for unpaid claims and claims adjustment expense of $701 million,
resulting in a premium deficiency reserve of $222 million. The second-lien risk in force at December 31, 2008
totaled $2.9 billion with 530 thousand second-lien policies in force compared to $3.8 billion of risk in force and
644 thousand policies in force at December 31, 2007. The second-lien business is expected to run-off over the next
10 to 12 years. Risk in force represents the full amount of second-lien loans insured reduced for contractual
AIG 2008 Form 10-K 77
American International Group, Inc., and Subsidiaries