AIG 2010 Annual Report Download - page 109

American International Group, Inc., and Subsidiaries
activity on AIG’s excess and umbrella policies. Many excess casualty policies were written on a multi-year basis in
the late 1990s, which limited AIG’s ability to respond to emerging market trends as rapidly as would otherwise be
the case. In subsequent years, AIG responded to these emerging trends by increasing rates and implementing
numerous policy form and coverage changes. This led to a significant improvement in experience beginning with
accident year 2001. In 2008, a significant portion of the adverse development from accident years 2002 and prior
also related to latent exposures, including pharmaceutical exposures as well as the construction defect and product
aggregate related exposures noted above. AIG’s exposure to these latent exposures was sharply reduced after 2002
due to significant changes in policy terms and conditions as well as underwriting guidelines. Another contributor
to the adverse development during 2008 and 2009 is that actual loss development for other large losses for
accident years 1998 and subsequent have emerged at higher than expected levels as compared to the loss
emergence pattern exhibited from earlier accident years. This has caused significant additional development for
accident years 1998 to 2002 and to a lesser extent for accident years 2003 to 2006. In 2009 the vast majority of the
prior accident year development was attributable to loss emergence that significantly exceeded the historical
average for this class of business.
AIG increased its estimate for its year-end 2009 loss reserve for excess casualty liabilities by more than
$1 billion, primarily relating to accident years 2006 and prior. The majority of the 2009 charge resulted from
management’s decision to place greater reliance on the experience of the five most recent calendar years, resulting
in significantly higher loss development factor assumptions for the year-end 2009 loss reserve review.
Even with these higher loss development factors, during the fourth quarter of 2010, loss emergence across all
accident years for excess casualty was approximately $115 million worse than expected and was concentrated in
accident years 2007 and 2008. The concentration of such losses in more recent accident years resulted in much
higher loss estimates at year-end 2010 because the experience is extrapolated not only for these years, but to all
years through the application of the loss development factors. The higher than expected loss emergence in the last
half of 2010, particularly in the fourth quarter, led management to select higher loss development factors than
those selected in 2009 because greater weight was placed on the adverse development in the recent calendar years
(i.e., the three most recent calendar years). In these low frequency/high severity classes of business, AIG applied
significant judgment to select an appropriate averaging period for loss development that is long enough to be
statistically credible while recognizing changing trends in a sufficiently responsive manner. AIG also considered
recent trends in large products liability verdicts in the United States given the impact of the recession and the
impact of anti-corporate sentiment in the mind of the general public, as well as the high attachment points at
which this business is written.
In determining the appropriate reserve estimate, in addition to the adverse claim emergence during late 2010,
management considered the continued exposure to latent product liability claim emergence for this long tail class
and the continued uncertainty of the expected loss ratios during the soft market conditions that prevailed in recent
accident years. At December 31, 2010, the calculation of AIG’s loss development factor assumptions was based on
giving much greater weight to the latest three calendar years of loss development experience. This change from
basing the loss development factor assumptions on the last five years provides still greater recognition of the
recent calendar-year experience than the assumptions used in the 2009 loss reserve review, and in management’s
judgment was warranted based on the developing trends described above. Approximately $80 million of the
reserve strengthening in the fourth quarter of 2010 pertained to accident year 2009, whereas approximately
$200 million was attributable to accident year 2008, $340 million to accident year 2007, $195 million to accident
year 2006, $100 million to accident years 1999 and prior, and approximately $95 million in the aggregate to
accident years 2000 through 2005.
For the year-end 2009 loss reserve review, in response to significantly higher than expected loss emergence, AIG
reviewed the indicated reserves for excess casualty under a variety of loss development assumptions. These
assumptions ranged from long term loss development averages, which utilized all or nearly all of the historical
data for this class, to short term averages which utilized only the latest three to five calendar years of loss
development experience. AIG gave greater recognition to the recent calendar year experience, resulting in
significantly higher loss development factor assumptions for the year-end 2009 loss reserve review. This change in
AIG 2010 Form 10-K 93