AIG 2010 Annual Report Download - page 64

American International Group, Inc., and Subsidiaries
less opportunity to improve their return on savings by purchasing a fixed annuity. With respect to yield curves,
steep yield curves provide a relative advantage to products such as fixed annuities that have a longer investment
horizon than alternative savings products like money market funds and certificates of deposit. After a period of
historically low interest rates during the latter part of 2010, interest rates generally increased at the longer part of
the yield curve late in the year. This change in the interest rate environment increased the relative attractiveness
of fixed annuities compared to alternative products. Should that interest rate environment continue or increase,
SunAmerica’s fixed annuity sales should improve. If the environment returns to one of lower interest rates, sales
volumes would continue to be challenged.
Spreads in the fixed annuity business are largely dependent upon three factors: base yields on the traditional
fixed income investments (e.g., bonds, mortgage- and asset-backed securities, commercial mortgages), returns on
alternative investments (hedge funds and private equity partnerships), and other income items such as the ML II
investment income and call and tender income. Base yields on the core fixed income portfolio are the primary
source of investment income and were lower than historical trends in 2009 and 2010 due to high levels of cash
and short-term investments accumulated for liquidity in that period. SunAmerica is focused on redeploying those
lower-yielding assets into higher-yielding traditional investments. To the extent this reinvestment is achieved, the
base investment yield and the spread over the cost of funds on the fixed annuity business should increase.
Alternative investment returns are affected by equity markets and the interest rate environment, but generally, a
favorable equity market should provide positive returns and also improve investment spreads.
SunAmerica has experienced a recovery of sales in its variable annuity business as various distribution partners
have resumed sales of SunAmerica’s products during 2010. SunAmerica recently announced that its formerly
largest distribution partner for variable annuities has agreed to resume distribution of SunAmerica’s products in
mid-2011. As a result of broader distribution opportunities and improvement in the equity markets, SunAmerica
expects continued improvement in its variable annuity sales.
SunAmerica companies issue variable annuity contracts with guaranteed benefits, primarily in the individual
variable annuity business. Those benefits expose SunAmerica to equity market and interest rate risks which
SunAmerica seeks to mitigate with a dynamic hedging program. The fees charged for guaranteed benefits were
generally set with the intent that fees would, over time, be sufficient to fund the hedging instruments and pay
potential claims under those benefits. In response to the difficult market environment of recent years that has
increased the cost of funding the hedging instruments, SunAmerica adjusted the levels of guarantees and changed
the basis for fees in response to market conditions, particularly changes in implied volatilities. These changes have
reduced the risk exposure in new variable annuity business and position SunAmerica for growth in sales in a very
competitive market.
The estimated gross profits used to amortize Deferred Policy Acquisition Costs (DAC), Value of Business
Acquired (VOBA) and SIA are subject to differing market returns and interest rate environments in any single
period. Estimated gross profits is comprised of net interest income, net realized investment gains and losses, fees,
surrender charges, expenses, and mortality and morbidity gains and losses. SunAmerica uses a reversion to mean
methodology to account for fluctuations in separate account returns. Continued favorable separate account returns
could trigger a favorable unlocking, where the reversion to mean assumption is reset. If current favorable equity
market returns continue in 2011, such an unlocking could occur during 2011, which could result in higher
amortization requirements in future periods.
SunAmerica generally obtains letters of credit in order to receive statutory recognition of its intercompany
reinsurance transactions, particularly with respect to redundant statutory reserve requirements on term insurance
and universal life with secondary guarantees (XXX and AXXX reserves). For this purpose, SunAmerica had a
$2.5 billion syndicated letter of credit facility outstanding at December 31, 2010, all of which relate to
intercompany life reinsurance transactions. SunAmerica has also obtained approximately $2.3 billion of letters of
credit on a bilateral basis, all of which relate to intercompany life reinsurance transactions. All of these
approximately $4.8 billion in letters of credit are due to mature on December 31, 2015. The fees paid to maintain
any bilateral letters of credit will likely be based on AIG’s long-term debt ratings.
48 AIG 2010 Form 10-K