AIG 2009 Annual Report Download - page 97

American International Group, Inc., and Subsidiaries
tested. In the course of these detailed reserve reviews an actuarial central estimate of the loss reserve is determined.
The sum of these central estimates for each class of business for each subsidiary provides an overall actuarial central
estimate of the loss reserve for that subsidiary. The ultimate process by which the actual carried reserves are
determined considers both the internal actuarial central estimate and numerous other internal and external factors
including a qualitative assessment of inflation and other economic conditions in the United States and abroad,
changes in the legal, regulatory, judicial and social environment, underlying policy pricing, terms and conditions, and
claims handling, as well as third party actuarial reviews that are periodically performed for key classes of business.
Loss reserve development can also be affected by commutations of assumed and ceded reinsurance agreements.
Actuarial Methods for Major Classes of Business
In testing the reserves for each class of business, a determination is made by AIG’s actuaries as to the most
appropriate actuarial methods. This determination is based on a variety of factors including the nature of the claims
associated with the class of business, such as frequency or severity. Other factors considered include the loss
development characteristics associated with the claims, the volume of claim data available for the applicable class, and
the applicability of various actuarial methods to the class. In addition to determining the actuarial methods, the
actuaries determine the appropriate loss reserve groupings of data. For example, AIG writes a great number of unique
subclasses of professional liability. For pricing or other purposes, it is appropriate to evaluate the profitability of each
subclass individually. However, for purposes of estimating the loss reserves for professional liability, it is appropriate
to combine the subclasses into larger groups. The greater degree of credibility in the claims experience of the larger
groups may outweigh the greater degree of homogeneity of the individual subclasses. This determination of data
segmentation and actuarial methods is carefully considered for each class of business. The segmentation and actuarial
methods chosen are those which together are expected to produce the most accurate estimate of the loss reserves.
Actuarial methods used by AIG for most long-tail casualty classes of business include loss development methods and
expected loss ratio methods, including ‘‘Bornhuetter Ferguson’’ methods described below. Other methods considered
include frequency/severity methods, although these are generally used by AIG more for pricing analysis than for loss
reserve analysis. Loss development methods utilize the actual loss development patterns from prior accident years to
project the reported losses to an ultimate basis for subsequent accident years. Loss development methods generally are
most appropriate for classes of business which exhibit a stable pattern of loss development from one accident year to the
next, and for which the components of the classes have similar development characteristics. For example, property
exposures would generally not be combined into the same class as casualty exposures, and primary casualty exposures
would generally not be combined into the same class as excess casualty exposures. Expected loss ratio methods are
generally utilized by AIG where the reported loss data lacks sufficient credibility to utilize loss development methods, such
as for new classes of business or for long-tail classes at early stages of loss development.
Expected loss ratio methods rely on the application of an expected loss ratio to the earned premium for the class of
business to determine the loss reserves. For example, an expected loss ratio of 70 percent applied to an earned
premium base of $10 million for a class of business would generate an ultimate loss estimate of $7 million. Subtracting
any reported paid losses and loss expense would result in the indicated loss reserve for this class. ‘‘Bornhuetter
Ferguson’’ methods are expected loss ratio methods for which the expected loss ratio is applied only to the expected
unreported portion of the losses. For example, for a long-tail class of business for which only 10 percent of the losses
are expected to be reported at the end of the accident year, the expected loss ratio would be applied to the 90 percent
of the losses still unreported. The actual reported losses at the end of the accident year would be added to determine
the total ultimate loss estimate for the accident year. Subtracting the reported paid losses and loss expenses would
result in the indicated loss reserve. In the example above, the expected loss ratio of 70 percent would be multiplied by
90 percent. The result of 63 percent would be applied to the earned premium of $10 million resulting in an estimated
unreported loss of $6.3 million. Actual reported losses would be added to arrive at the total ultimate losses. If the
reported losses were $1 million, the ultimate loss estimate under the ‘‘Bornhuetter Ferguson’’ method would be
$7.3 million versus the $7 million amount under the expected loss ratio method described above. Thus, the
‘‘Bornhuetter Ferguson’’ method gives partial credibility to the actual loss experience to date for the class of business.
Loss development methods generally give full credibility to the reported loss experience to date. In the example
above, loss development methods would typically indicate an ultimate loss estimate of $10 million, as the reported
losses of $1 million would be estimated to reflect only 10 percent of the ultimate losses.
89 AIG 2009 Form 10-K