AIG 2014 Annual Report Download - page 216

ITEM 7 / CRITICAL ACCOUNTING ESTIMATES
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investments. See Note 9 to the Consolidated Financial Statements for additional information on shadow loss recognition. In
applying shadow loss recognition, the Company overlays unrealized gains onto loss recognition tests without revising the
underlying test. Accordingly, there is limited additional judgment in this process.
Guaranteed Benefit Features of Variable Annuity Products (Life Insurance Companies)
Variable annuity products offered by our Retirement Income Solutions and Group Retirement product lines offer guaranteed
benefit features. These guaranteed features include guaranteed minimum death benefits (GMDB) that are payable in the event
of death or other instances, and living benefits that are payable in the event of annuitization, or, in other instances, at specified
dates during the accumulation period. Living benefits include guaranteed minimum withdrawal benefits (GMWB), guaranteed
minimum income benefits (GMIB), and guaranteed minimum account value benefits (GMAV). See Note 14 to the Consolidated
Financial Statements for additional information on these features. For GMDB, our most widely offered guaranteed benefit
feature, the liabilities included in Future policyholder benefits at December 31, 2014 and 2013 were $401 million and $355
million, respectively. The fair value of GMWB and GMAV embedded derivatives included in Policyholder contract deposits was
a net liability of $957 million at December 31, 2014 and a net asset of $37 million at December 31, 2013.
The liabilities for GMDB and GMIB, which are recorded in Future policyholder benefits, represent the expected value of
benefits in excess of the projected account value, with the excess recognized ratably over the accumulation period based on
total expected assessments, through Policyholder benefits and losses incurred. The liabilities for GMWB and GMAV, which are
recorded in Policyholder contract deposits, are accounted for as embedded derivatives measured at fair value, with changes in
the fair value of the liabilities recorded in Other realized capital gains (losses).
Our exposure to the guaranteed amounts is equal to the amount by which the contract holder’s account balance is below the
amount provided by the guaranteed feature. A variable annuity contract may include more than one type of guaranteed benefit
feature; for example, it may have both a GMDB and a GMWB. However, a policyholder can only receive payout from one
guaranteed feature on a contract containing a death benefit and a living benefit, i.e. the features are mutually exclusive, so the
exposure to the guaranteed amount for each feature is not additive to that of other features. A policyholder cannot purchase
more than one living benefit on one contract. Declines in the equity markets, increased volatility and a sustained low interest
rate environment increase our exposure to potential benefits under the guaranteed features, leading to an increase in the
liabilities for those benefits. See Estimated Gross Profits for Investment-Oriented Products (Life Insurance) below for sensitivity
analysis which includes the sensitivity of reserves for guaranteed benefit features to changes in the assumptions for equity
market returns, volatility and mortality. For a further discussion of the risks related to guaranteed benefit features of variable
annuities, our dynamic hedging program and risks of AIG’s unhedged exposures, see Item 1A. — Risk Factors — Business
and Operations.
The reserving methodology and assumptions used to measure the liabilities of our two largest guaranteed benefit features are
presented in the following table:
Reserving Methodology Assumptions and Accounting Judgments
GMDB
We determine the GMDB liability at each balance sheet date
by estimating the expected value of death benefits in excess of
the projected account balance and recognizing the excess
ratably over the accumulation period based on total expected
fees. See Note 14 to the Consolidated Financial Statements
for additional information on how we reserve for variable
annuity products with guaranteed benefit features.
Key assumptions include :
• Interest rates, which vary by year of issuance and products
• Mortality rates, which are based upon actual experience
modified to allow for variations in policy form
• Lapse rates, which are based upon actual experience
modified to allow for variations in policy form
• Investment returns, using assumptions from a randomly
generated model
• In applying asset growth assumptions for the valuation of
the GMDB liability, we use a “reversion to the mean”