AIG 2008 Annual Report Download - page 93

Long-Tail Reserves
Estimation of ultimate net losses and loss expenses (net losses) for long-tail casualty classes of business is a
complex process and depends on a number of factors, including the class and volume of business involved.
Experience in the more recent accident years of long-tail casualty classes of business shows limited statistical
credibility in reported net losses because a relatively low proportion of net losses would be reported claims and
expenses and an even smaller percentage would be net losses paid. Therefore, IBNR would constitute a relatively
high proportion of net losses.
AIG’s carried net long-tail loss reserves are tested using loss trend factors that AIG considers appropriate for
each class of business. A variety of actuarial methods and assumptions is normally employed to estimate net losses
for long-tail casualty classes of businesses. These methods ordinarily involve the use of loss trend factors intended
to reflect the annual growth in loss costs from one accident year to the next. For the majority of long-tail casualty
classes of business, net loss trend factors approximated five percent. Loss trend factors reflect many items including
changes in claims handling, exposure and policy forms, current and future estimates of monetary inflation and
social inflation and increases in litigation and awards. These factors are periodically reviewed and adjusted, as
appropriate, to reflect emerging trends which are based upon past loss experience. Thus, many factors are implicitly
considered in estimating the year to year growth in loss costs.
A number of actuarial assumptions are generally made in the review of reserves for each class of business. For
longer-tail classes of business, actuarial assumptions generally are made with respect to the following:
• Loss trend factors which are used to establish expected loss ratios for subsequent accident years based on the
projected loss ratio for prior accident years.
• Expected loss ratios for the latest accident year (i.e., accident year 2008 for the year-end 2008 loss reserve
analysis) and, in some cases for accident years prior to the latest accident year. The expected loss ratio
generally reflects the projected loss ratio from prior accident years, adjusted for the loss trend (see above)
and the effect of rate changes and other quantifiable factors on the loss ratio. For low-frequency, high-
severity classes such as excess casualty, expected loss ratios generally are used for at least the three most
recent accident years.
• Loss development factors which are used to project the reported losses for each accident year to an ultimate
basis. Generally, the actual loss development factors observed from prior accident years would be used as a
basis to determine the loss development factors for the subsequent accident years.
AIG records quarterly changes in loss reserves for each of its many General Insurance classes of business. The
overall change in AIG’s loss reserves is based on the sum of these classes of business changes. For most long-tail
classes of business, the process of recording quarterly loss reserve changes involves determining the estimated
current loss ratio for each class of coverage. This loss ratio is multiplied by the current quarter’s net earned premium
for that class of coverage to determine the current accident quarter’s total estimated net incurred loss and loss
expense. The change in loss reserves for the quarter for each class is thus the difference between the net incurred loss
and loss expense, estimated as described above, and the net paid losses and loss expenses in the quarter. Also any
change in estimated ultimate losses from prior accident years, either positive or negative, is reflected in the loss
reserve for the current quarter.
Details of the Loss Reserving Process
The process of determining the current loss ratio for each class of business is based on a variety of factors.
These include, but are not limited to, the following considerations: prior accident year and policy year loss ratios;
rate changes; changes in coverage, reinsurance, or mix of business; and actual and anticipated changes in external
factors affecting results, such as trends in loss costs or in the legal and claims environment. The current loss ratio for
each class of business reflects input from actuarial, underwriting and claims staff and is intended to represent
management’s best estimate of the current loss ratio after reflecting all of the factors described above. At the close of
each quarter, the assumptions underlying the loss ratios are reviewed to determine if the loss ratios remain
appropriate. This process includes a review of the actual claims experience in the quarter, actual rate changes
achieved, actual changes in coverage, reinsurance or mix of business, and changes in certain other factors that may
AIG 2008 Form 10-K 87
American International Group, Inc., and Subsidiaries