AIG 2015 Annual Report Download - page 216

ITEM 7 / CRITICAL ACCOUNTING ESTIMATES
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Reserving Methodology Assumptions and Accounting Judgments
• Policyholder behavior, including mortality, lapses,
withdrawals and benefit utilization. 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, which are calibrated to
observable interest rate and equity option prices
• 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 below
the long-term annual rate assumption impacts 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 for 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. The use of a reversion to the mean assumption is common within
the industry; however, the parameters used in the methodology are subject to judgment and vary within the industry. See
Results of Operations – Life Insurance Companies DAC and Reserves – Reversion to the Mean for additional discussion.
The following table summarizes the sensitivity of changes in certain assumptions for DAC and SIA, embedded
derivatives and other reserves related to guaranteed benefits and URR, the related hypothetical impact on December
31, 2015 balances and the resulting hypothetical impact on pre-tax income, before hedging. Changes in net
investment spread assumptions primarily affect DAC and SIA in our Fixed Annuities product line. Changes in interest