AIG 2010 Annual Report Download - page 113

American International Group, Inc., and Subsidiaries
strategies. In addition, a projected shift in losses over time from indemnity to medical claims, which AIG has
observed in California and expects to experience in other markets, is expected to result in worsening claims
experience. AIG’s conclusion that the worsening experience necessitated a strengthening of the reserves was
confirmed by an independent third-party actuarial review during the fourth quarter of 2010. Approximately
75 percent of the year-end 2010 reserve strengthening for this business pertained to accident years 2007 through
2009.
Construction and Commercial Risk Management: The construction and commercial risk management
businesses consist of a combination of primary workers’ compensation, general liability and commercial automobile
coverages. The experience in the excess workers’ compensation class discussed under Excess Workers’
Compensation above that led to a fourth quarter 2010 change in estimate also significantly affected these classes.
Adverse loss development of $109 million was recognized for the construction and commercial risk management
businesses during the first nine months of 2010. Although significant improvements in claims handling were
believed to be a cause of the earlier emergence of claims during this period, as with excess workers’ compensation,
the adverse loss emergence during 2010, including in the fourth quarter, led AIG to conclude that the worsening
experience now represented a credible trend. AIG’s conclusion that the worsening experience with respect to the
construction risk management business necessitated a strengthening of the reserves was confirmed by a third-party
actuarial review during the fourth quarter of 2010. Construction risk management represented approximately
$250 million of the fourth quarter increase in estimated loss reserves.
National Accounts — Loss-Sensitive Portfolio: Loss-sensitive business refers to policies whose premiums vary
with the level of losses incurred; such premiums are referred to by AIG as loss-cost premiums. In 2009 and prior
years, the method for establishing loss reserve balances was to match loss-cost premiums for this class against paid
losses, consistent with the underlying loss-sensitive contracts. In 2010, system enhancements allowed for a more
granular view of data and transactions, leading to the use of alternative reserving methods. These alternative
methods led to the decision to increase estimated loss reserves by approximately $400 million in the fourth quarter
of 2010.
See Chartis Results herein for further discussion of net loss development.
Overview of Loss Reserving Process
Chartis loss reserves can generally be categorized into two distinct groups. One group is short-tail classes of
business consisting principally of property, personal lines and certain casualty classes. The other group is long-tail
casualty classes of business which includes excess and umbrella liability, D&O, professional liability, medical
malpractice, workers’ compensation, general liability, products liability and related classes.
Short-Tail Reserves
For operations writing short-tail coverages, such as property coverages, the process of recording quarterly loss
reserves is generally geared toward maintaining an appropriate reserve for the outstanding exposure, rather than
determining an expected loss ratio for current business. For example, the IBNR reserve required for a class of
property business might be expected to approximate 20 percent of the latest year’s earned premiums, and this
level of reserve would generally be maintained regardless of the loss ratio emerging in the current quarter. The
20 percent factor would be adjusted to reflect changes in rate levels, loss reporting patterns, known exposure to
unreported losses, or other factors affecting the particular class of business.
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
AIG 2010 Form 10-K 97