AIG 2015 Annual Report Download - page 151

ITEM 7 / INSURANCE RESERVES / LIFE INSURANCE COMPANIES
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Differences in Valuation of Embedded Derivatives and Economic Hedge Target
The variable annuity hedging program utilizes an economic hedge target, which represents an estimate of the underlying
economic drivers of the embedded derivatives. The economic hedge target differs from the U.S. GAAP valuation of the GMWB
and GMAB embedded derivatives due to the following:
• Rider fees are 100 percent included in the economic hedge target present value calculations; the U.S. GAAP valuation
reflects those collected fees attributed to the embedded derivative such that the initial value at contract issue equals zero;
• Actuarial assumptions for U.S. GAAP are adjusted to remove explicit risk margins, including margins for policyholder
behavior and fund basis risk, and use best estimate assumptions for the economic hedge target; and
• Non-performance adjustment (NPA or “own credit” risk) is excluded from the discount rates used for the economic hedge
target.
The market value of the hedge portfolio compared to the economic hedge target at any point in time may be different and is not
expected to be fully offsetting. In addition to the derivatives held in conjunction with the variable annuity hedging program, the
Life Insurance Companies have cash and invested assets available to cover future claims payable under these guarantees.
The primary sources of difference between the change in the fair value of the hedging portfolio and the economic hedge target
include:
• Basis risk due to the variance between expected and actual fund returns, which may be either positive or negative;
• Realized volatility versus implied volatility;
• Actual versus expected changes in the hedge target related to items not subject to hedging, particularly policyholder
behavior; and
• Risk exposures that we have elected not to explicitly or fully hedge, which in 2014 and 2013 included a portion of the
interest rate risk.
DAC
The following table summarizes the major components of the changes in Life Insurance Companies DAC, including
VOBA:
Years Ended December 31,
(in millions) 2015 2014 2013
Balance, beginning of year $7,258 $ 6,920 $ 5,815
Acquisition costs deferred 1,288 1,114 1,034
Amortization expense:
Update of assumptions included in pre-tax operating income 79 183 129
Related to realized capital gains and losses (1) (23) (23)
All other operating amortization (994) (887) (780)
Increase (decrease) in DAC due to foreign exchange (34) (32) (39)
Other change in DAC 23 343 -
Change related to unrealized depreciation (appreciation) of investments 848 (360) 784
Balance, end of year* $8,467 $ 7,258 $ 6,920
* DAC balance excluding the amount related to unrealized depreciation (appreciation) of investments was $9.1 billion, $8.7 billion, and $8.0 billion at December
31, 2015, 2014 and 2013, respectively.
The net adjustments to DAC amortization from the update of actuarial assumptions for estimated gross profits in 2015 and
2014, including those reported within change in DAC related to net realized capital gains (losses), represented one percent
and two percent of the DAC balance excluding the amount related to unrealized depreciation (appreciation) of investments as
of December 31, 2015 and 2014, respectively.