AIG 2013 Annual Report Download - page 286

Policy acquisition costs and policy issuance costs related to universal life and
investment-type products (collectively, investment-oriented products) are deferred and amortized, with interest, in
relation to the incidence of estimated gross profits to be realized over the estimated lives of the contracts. Estimated
gross profits include net investment income and spreads, net realized investment gains and losses, fees, surrender
charges, expenses, and mortality gains and losses. In each reporting period, current period amortization expense is
adjusted to reflect actual gross profits. If estimated gross profits change significantly, DAC is recalculated using the
new assumptions, and any resulting adjustment is included in income. If the new assumptions indicate that future
estimated gross profits are higher than previously estimated, DAC will be increased resulting in a decrease in
amortization expense and increase in income in the current period; if future estimated gross profits are lower than
previously estimated, DAC will be decreased resulting in an increase in amortization expense and decrease in
income in the current period. Updating such assumptions may result in acceleration of amortization in some products
and deceleration of amortization in other products. DAC is grouped consistent with the manner in which the
insurance contracts are acquired, serviced and measured for profitability and is reviewed for recoverability based on
the current and projected future profitability of the underlying insurance contracts.
To estimate future estimated gross profits for variable annuity products, a long-term annual asset growth assumption
is applied to determine the future growth in assets and related asset-based fees. In determining the asset growth
rate, the effect of short-term fluctuations in the equity markets is partially mitigated through the use of a ‘‘reversion to
the mean’’ methodology whereby short-term asset growth above or below long-term annual rate assumptions impact
the growth assumption applied to the five-year period subsequent to the current balance sheet date. The reversion to
the mean methodology allows us to maintain our long-term growth assumptions, while also giving consideration to
the effect of actual investment performance. When actual performance significantly deviates from the annual
long-term growth assumption, as evidenced by growth assumptions in the five-year reversion to the mean period
falling below a certain rate (floor) or above a certain rate (cap) for a sustained period, judgment may be applied to
revise or ‘‘unlock’’ the growth rate assumptions to be used for both the five-year reversion to the mean period as well
as the long-term annual growth assumption applied to subsequent periods.
DAC held for investment-oriented products is also adjusted to
reflect the effect of unrealized gains or losses on fixed maturity and equity securities available for sale on estimated
gross profits, with related changes recognized through Other comprehensive income (shadow DAC). The adjustment
is made at each balance sheet date, as if the securities had been sold at their stated aggregate fair value and the
proceeds reinvested at current yields. Similarly, for long-duration traditional insurance contracts, if the assets
supporting the liabilities maintain a temporary net unrealized gain position at the balance sheet date, loss recognition
testing assumptions are updated to exclude such gains from future cash flows by reflecting the impact of
reinvestment rates on future yields. If a future loss is anticipated under this basis, any additional shortfall indicated by
loss recognition tests is recognized as a reduction in accumulated other comprehensive income (shadow loss
recognition). Similar to other loss recognition on long-duration insurance contracts, such shortfall is first reflected as a
reduction in DAC and secondly as an increase in liabilities for future policy benefits. The change in these
adjustments, net of tax, is included with the change in net unrealized appreciation of investments that is credited or
charged directly to Other comprehensive income.
For some products, policyholders
can elect to modify product benefits, features, rights or coverages by exchanging a contract for a new contract or by
amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. These
transactions are known as internal replacements. If the modification does not substantially change the contract, we
do not change the accounting and amortization of existing DAC and related actuarial balances. If an internal
replacement represents a substantial change, the original contract is considered to be extinguished and any related
DAC or other policy balances are charged or credited to income whereas any new deferrable costs associated with
the replacement contract are deferred.
Value of Business Acquired (VOBA) is determined at the time of acquisition and is reported in the Consolidated
Balance Sheets with DAC. This value is based on the present value of future pre-tax profits discounted at yields
applicable at the time of purchase. For participating life, traditional life and accident and health insurance products,
VOBA is amortized over the life of the business in a manner similar to that for DAC based on the assumptions at
purchase. For investment-oriented products, VOBA is amortized in relation to estimated gross profits and adjusted for
the effect of unrealized gains or losses on fixed maturity and equity securities available for sale in a manner similar
to DAC.
..................................................................................................................................................................................................................................
AIG 2013 Form 10-K268
ITEM 8 / NOTE 9. DEFERRED POLICY ACQUISITION COSTS
Investment-oriented contracts:
Shadow DAC and Shadow Loss Recognition:
Internal Replacements of Long-duration and Investment-oriented Products:
..................................................................................................................................................................................