AIG 2014 Annual Report Download - page 217

ITEM 7 / CRITICAL ACCOUNTING ESTIMATES
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Reserving Methodology Assumptions and Accounting Judgments
methodology, similar to that applied for DAC. For a
description of this methodology, see Estimated Gross
Profits for Investment-Oriented Products (Life Insurance
Companies) below.
GMWB
GMWB living benefits are embedded derivatives that are
required to be bifurcated from the host contract and carried at
fair value. The fair value estimates of the living benefit
guarantees include assumptions such as equity market
returns, interest rates, market volatility, and policyholder
behavior. See Note 14 to the Consolidated Financial
Statements for additional information on how we reserve for
variable annuity products with guaranteed benefit features,
and Note 5 to the Consolidated Financial Statements for
information on fair value measurement of these embedded
derivatives, including how AIG incorporates its own non-
performance risk.
The fair value of the embedded derivatives is based on
actuarial and capital market assumptions related to projected
cash flows over the expected lives of the contracts. Key
assumptions include:
• Equity market returns
• Interest rates
• Market volatility
• Benefits and related fees assessed, when applicable
• Policyholder behavior, including mortality, exercise of
guarantees and policy lapses. Estimates of future
policyholder behavior are subjective and based primarily on
our historical experience
• In applying asset growth assumptions for the valuation of
GMWBs, we use market-consistent assumptions consistent
with fair value measurement
• Allocation of fees between the embedded derivative and
host contract
Estimated Gross Profits for Investment–Oriented Products (Life Insurance Companies)
Policy acquisition costs and policy issuance costs that are incremental and directly related to the successful acquisition of new
or renewal of existing insurance contracts related to universal life and investment-type products (collectively, investment-
oriented products) are generally deferred and amortized, with interest, in relation to the incidence of estimated gross profits to
be realized over a period that approximates the estimated lives of the contracts, except in instances where significant negative
gross profits are expected in one or more periods. 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 estimating future
gross profits, lapse assumptions require judgment and can have a material impact on DAC amortization. For fixed deferred
annuity contracts, the future spread between investment income and interest credited to policyholders is a significant
judgment, particularly in a low interest rate environment.
If the assumptions used for estimated gross profits change significantly, DAC and related reserves, including VOBA, SIA,
guaranteed benefit reserves and URR, are recalculated using the new assumptions, and any resulting adjustment is included
in income. Updating such assumptions may result in acceleration of amortization in some products and deceleration of
amortization in other products.
In estimating future gross profits for variable annuity products, a long-term annual asset growth assumption of 8.5% (before
expenses that reduce the asset base from which future fees are projected) is applied to estimate 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