AIG 2010 Annual Report Download - page 111

American International Group, Inc., and Subsidiaries
Medicare & Medicaid Services in 2009, which are expected to result in future prescription drug costs being borne
by workers’ compensation insurers to a significantly greater degree than in the past and thus likely to lead to
further deteriorating trends for the excess workers’ compensation class of business.
In addition, approximately 20 percent of the reported claims emanate from excess of loss reinsurance contracts
provided by Chartis to other third-party insurers in accident years 2002 and prior. These reinsurance contracts
generally include the so-called ‘‘follow the fortunes clause’’ whereby claims management is performed by the
ceding insurers and the outcomes of these efforts are binding on Chartis as the reinsurer. Chartis has virtually no
ability to affect the outcomes of these claims.
Moreover, underwriting actions in recent years have led to a significant increase in insured retention levels,
which reduce the frequency of moderate-severity losses but extend the time period of first report of claim, causing
further unpredictability in loss development patterns.
During the fourth quarter of 2010, AIG conducted its comprehensive loss reserve analysis using a variety of
actuarial techniques to project future loss development for this very long-tail class. As part of this analysis, AIG
compared and contrasted the traditional techniques that have been used for this class with an alternative approach
that focuses more explicitly on projecting the effect of future calendar year trends, placing less weight on prior-
period loss development ratios due to the increased evidence of changes to the claims environment. To this end,
AIG engaged a third-party actuary that uses such alternative approaches to supplement the extensive analysis
performed by AIG as it conducted its comprehensive loss review of its year-end loss reserves. The third-party
actuary provided an additional perspective for the excess workers’ compensation class by using a method that
management considered to be particularly suited to the excess workers’ compensation class, given its long-tail
nature. These various actuarial analyses all indicated a substantial increase in loss estimates from the prior-year
level. AIG responded to this increased loss indication by evaluating a range of loss development scenarios
including developing the tail factors that extrapolate the claims projections as far as 40 years into the future. Due
to the extremely long-tail nature of this class, the impact of the selected change in loss development assumptions
affected many accident years and led to an overall strengthening of approximately $825 million, before discount.
Approximately $430 million of the reserve strengthening in the fourth quarter of 2010 pertained to accident years
1999 and prior, with an additional $160 million attributable to accident year 2000, $140 million to accident year
2001, $80 million to accident year 2002, and only approximately $10 million attributable to 2003 and subsequent
years.
For the year-end 2009 loss reserve review, AIG increased the loss development assumptions for this class of
business, resulting in approximately a $925 million increase in reserves. The increased loss development
assumptions were based on an additional actuarial study performed by AIG in response to the emergence of
losses in accident years 1999 and prior. This study analyzed the development patterns emanating from the AIG
claims staff projections of expected ultimate cost for each open claim. No significant changes in assumptions were
made in the year-end 2008 loss reserve reviews.
D&O and Related Management Liability Classes of Business: AIG experienced a significant favorable
development during 2008, but only a relatively minor amount of favorable development in 2009 and 2010. The
favorable development over the three-year period related primarily to accident years 2004 and 2005, and to a
lesser extent accident years 2003 and 2006. Loss cost trends for D&O and related management liability classes of
business were adverse in accident years 2002 and prior due to a variety of factors, including an increase in
frequency and severity of corporate bankruptcies; the increase in the frequency of financial restatements; the sharp
rise in market capitalization of publicly traded companies; and the increase in the number of initial public
offerings. The 2003 through 2006 period was marked by a significant reduction in claims related to these factors;
thus the expected loss ratios initially established for these accident years have developed favorably, particularly for
2004 and 2005. Beginning in accident year 2007, claims relating to the credit crisis resulted in increased overall
claim activity. AIG utilizes ground-up claims projections by AIG claims staff as a benchmark to select the loss
reserves for this business; these projections are updated annually.
AIG 2010 Form 10-K 95