• this Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) of this Annual Report on Form 10-K.
• changes in benefit reserves and deferred policy acquisition costs (DAC), value of business acquired (VOBA), and sales inducement assets (SIA) related to net realized capital gains and losses;
• non-qualifying derivative hedging activities, excluding net realized capital gains and losses;
· Ratios: We, along with most property and casualty insurance companies, use the loss ratio, the expense ratio and the combined ratio as measures of underwriting performance. These ratios are relative measurements that describe, for every $100 of net premiums earned, the amount of losses and loss adjustment expenses, and the amount of other underwriting expenses that would be incurred. A combined ratio of less than 100 indicates underwriting income and a combined ratio of over 100 indicates an underwriting loss. The underwriting environment varies across countries and products, as does the degree of litigation activity, all of which affect such ratios. In addition, investment returns, local taxes, cost of capital, regulation, product type and competition can have an effect on pricing and consequently on profitability as reflected in underwriting income and associated ratios.
We acquired Ageas Protect Limited (Ageas Protect) on December 31, 2014 from international insurer Ageas Group for approximately $308 million. Our agreement to acquire Ageas Protect was announced in August 2014. Ageas Protect is a leading provider of life protection products in the United Kingdom, recognized in its market for product innovation, the effective use of technology and high quality service. We expect the acquisition of Ageas Protect to enhance our global Consumer Insurance business and strengthen our presence in the United Kingdom, where we already offer personal accident, health and travel insurance coverage, as well as customized insurance solutions for high net worth individuals through AIG Private Client Group.
The following table presents Property Casualty’s net premiums written by major line of business:
The increase in net premiums written was partially offset by the effect of catastrophe bond transactions which provide coverage for several years with ceded written premium recognized at the inception of the transaction. In 2013, we entered into two multi-year catastrophe bond transactions, which provide $525 million of indemnity protection, in the aggregate, against U.S., Caribbean and Gulf of Mexico named storms, and U.S. and Canadian earthquakes through the end of 2018. These transactions reduced net premiums written in 2013 by $140 million. There was no similar reduction in 2012 as our previous catastrophe bond issuance occurred in the fourth quarter of 2011.
The general operating expense ratio decreased by 0.2 points in 2013, compared to 2012, primarily due to a reduction in bad debt expense, which contributed approximately 0.8 points to the decrease, and lower strategic initiatives expenses, which contributed approximately 0.6 points to the decrease. These decreases were partially offset by the increase in employee incentive plan expense, which represented an approximately 1.0 point increase.
Pre-tax operating income for 2014 decreased slightly compared to 2013, as a decrease in net investment income was only partially offset by an increase in fee income. The increase in fee income was driven by growth in reserves and assets under management, primarily from strong development of the stable value wrap business. The notional amount of stable value wrap assets under management at December 31, 2014 grew by $7.8 billion or 32 percent from December 31, 2013, which excluded a $2.5 billion deposit to the separate accounts for a stable value funding agreement. Growth in reserves also reflected a GIC deposit of $450 million in the fourth quarter of 2014 under a funding agreement-backed notes issuance program, in which an unaffiliated, non-consolidated statutory trust issues to investors medium-term notes, which are secured by GICs issued by one of the Life Insurance Companies. Under the funding agreement-backed notes program, issuances will be made opportunistically based upon pricing and demand available in the marketplace.
The following table presents a reconciliation of Institutional Markets premiums and deposits to GAAP premiums:
The decrease in premiums in 2014 compared to 2013 was primarily due to a high volume of single-premium products sold in 2013, including life-contingent payout annuities. Sales of these products decreased in 2014 compared to 2013 due to a more competitive environment as well as continued low interest rates. The increase in deposits in 2014 compared to 2013 included a $2.5 billion deposit to the separate accounts of one of the Life Insurance Companies for a stable value wrap funding agreement. The majority of stable value wrap sales are measured based on the notional amount included in assets under management, but do not include the receipt of funds that would be included in premiums and deposits. The increase in deposits in 2014 compared to 2013 also reflected a $450 million GIC issued in 2014.
$440 million in 2013. These expenses, while not deferrable, are expected to generate business that has an average expected overall persistency of approximately five years and, in Japan, where the majority of the expenses are incurred, approximately nine years. Excluding the impact of foreign exchange, direct marketing expenses decreased by approximately $24 million in 2014 compared to 2013. Direct marketing accounted for approximately 17 percent of net premiums written in both 2014 and 2013.
Net investment income decreased in 2014 compared to 2013, primarily due to a decrease in interest rates during 2014, as yields on new purchases were lower than the weighted average yield of the overall portfolio, lower income on alternative investments, and lower income associated with investments accounted for under the fair value option method as an increase related to the PICC P&C rights offerings was more than offset by a decrease from fixed maturity investments accounted for under the fair value option. These were partially offset by the effect of continued portfolio diversification. Additionally, the decrease in allocated net investment income was also due to a reduction in net loss reserves.
EMEA net premiums written increased in 2013 compared to 2012, due to growth in all lines of Personal Insurance.
Net credit valuation adjustment gains of $291 million and $444 million were recognized in 2014 and 2013, respectively. The decrease resulted primarily from lower gains on assets due to more significant widening of counterparty credit spreads in 2014 compared to 2013.
Fair value appreciation on ABS CDOs was $954 million in 2013 driven primarily by improved collateral pricing due to improvements in home price indices and amortization of the underlying collateral.
Net investment income for 2013 decreased compared to 2012 primarily due to fair value gains from our investments in ML II, ML III and AIA prior to their sale in 2012.
(a) The December 31, 2013 balances have been reclassified between the Property Casualty and Personal Insurance lines of business. The impact of this correction was a total decrease of $325 million in Property Casualty and a corresponding increase in Personal Insurance, with no income statement or balance sheet impact.
AIG net loss reserves represent our best estimate of the liability for net losses and loss adjustment expenses as of December 31, 2014. While we regularly review the adequacy of established loss reserves, there can be no assurance that our ultimate loss reserves will not develop adversely in future years and materially exceed our loss reserves as of December 31, 2014. In our opinion, such adverse development and resulting increase in reserves are not likely to have a material adverse effect on our consolidated financial condition, although such events could have a material adverse effect on our consolidated results of operations for an individual reporting period.
(a) See tables below for details of prior year development by business unit, accident year and major class of business.
severity trends for various Professional Liability classes of business which appear to be behaving differently in the post financial crisis years than when reviewed in total.
The following table summarizes development, (favorable) or unfavorable, of incurred losses and loss adjustment expenses for accident year 2004 and prior by major class of business and driver of development:
In the fourth quarter of 2013, we revised the growth rate assumptions for the five-year reversion to the mean period for the Group Retirement product line in our Retirement segment, because annual growth assumptions indicated for that period had fallen below our floor of zero percent due to the favorable performance of equity markets. This adjustment increased Retirement pre-tax operating income by $35 million in 2013. For variable annuities in the Retirement Income Solutions product line, the assumed annual growth rate has remained above zero percent for the five-year reversion to the mean period and therefore has not met the criteria for adjustment; however, additional favorable equity market performance in excess of long-term assumptions could result in unlocking in this product line in the future, with a positive effect on pre-tax income in the period of the unlocking. See Critical Account Estimates - Estimated Gross Profits for Investment-Oriented Products (Life Insurance Companies) for additional discussion of assumptions related to our reversion to the mean methodology.
• payments received relating to the sale of the underlying assets held by ML II of approximately $1.6 billion;
The overall hedging activity for the assets and liabilities of the DIB is executed by GCM. The value of hedges related to the non-derivative assets and liabilities of AIGFP in the DIB is included within the assets, liabilities and operating results of GCM and is not included within the DIB’s assets, liabilities or operating results.
(b) Does not reflect unrecognized tax benefits of $4.4 billion, the timing of which is uncertain.
We believe that our Life Insurance Companies have adequate financial resources to meet the payments actually required under these obligations. These subsidiaries have substantial liquidity in the form of cash and short-term investments. In addition, our Life Insurance Companies maintain significant levels of investment grade rated fixed maturity securities, including substantial holdings in government and corporate bonds, and could seek to monetize those holdings in the event operating cash flows are insufficient. We expect liquidity needs related to GIC liabilities to be funded through cash flows generated from maturities and sales of invested assets.
The following table provides the rollforward of AIG’s total debt outstanding:
Each of the following systemic risks is considered a market risk:
Equity prices. We are exposed to changes in equity market prices affecting a variety of instruments. Changes in equity prices can affect the valuation of publicly-traded equity shares, investments in private equity, hedge funds and mutual funds, exchange-traded funds (ETFs), and other equity-linked capital market instruments as well as equity-linked insurance products, including but not limited to index annuities, variable annuities, universal life insurance and variable universal life insurance.
and liquidity levels under specific stress tests. At the market risk level, the framework measures our overall exposure to each systemic market risk change on an economic basis.
In addition, we continue to enhance economic, U.S. GAAP accounting and statutory capital-based risk measures at the market risk level, business-unit level and firm-wide levels. This process aims to ensure that we have a comprehensive view of the impact of our market risk exposures.
(a) At December 31, 2014, the analysis covered $290 billion of $309 billion interest-rate sensitive assets. Excluded are $1 billion in DIB assets, $8 billion of loans, and $4 billion of investments in life settlements. In addition, $5 billion of assets across various asset categories were excluded due to modeling limitations. At December 31, 2013, the analysis covered $283 billion of $306 billion interest-rate sensitive assets. Excluded are $6 billion in DIB assets, $5 billion of loans, and $4 billion of investments in life settlements. In addition, $8 billion of assets across various asset categories were excluded due to modeling and/or data limitations.
We conduct a comprehensive loss reserve review at least annually for each of the Non-Life Insurance Company and class of business. The reserve analysis for each class of business is performed by the actuarial personnel who are most familiar with that class of business. In this process, the actuaries are required to make numerous assumptions, including the selection of loss development factors and loss cost trend factors. They are also required to determine and select the most appropriate actuarial methods for each business class. Additionally, they must determine the segmentation of data that will enable the most suitable test of reserve adequacy. In the course of these detailed reserve reviews an actuarial central estimate of the loss reserve is determined. The sum of these central estimates for each class of business provides an overall actuarial central estimate of the loss reserve for that class.
Structural drivers analytics seek to explain the underlying drivers of frequency/severity. A structural drivers analysis of frequency/severity is particularly useful for understanding the key drivers of uncertainty in the ultimate loss cost. For example, for the excess workers’ compensation class of business, we have attempted to corroborate our judgment by considering the impact on severity of the future propensity for deterioration of an injured worker’s medical condition, the impact of price inflation on the various categories of medical expense and cost of living adjustments on indemnity benefits, the impact of injured worker mortality and claim specific settlement and loss mitigation strategies, etc., using the following:
Various factors contribute to the complexity and difficulty in determining the future development of claims. Significant factors that influence the claims estimation process include court resolutions and judicial interpretations which broaden the intent of the policies and scope of coverage. The current case law can be characterized as still evolving, and there is little likelihood that any firm direction will develop in the near future. Additionally, the exposures for cleanup costs of hazardous waste dump sites
For classes of business other than the classes discussed below, there is generally some potential for deviation in both the loss cost trend and loss development factor assumptions.
AIG’s loss reserve analyses do not generally provide a range of loss reserve estimates. A large portion of the loss reserves from the Non-Life Insurance Companies business relates to longer-tail casualty classes of business, such as excess casualty and D&O, which are driven by severity rather than frequency of claims. Using the reserving methodologies described above, our actuaries determine their actuarial central estimates of the loss reserves and advise management on their final recommendation for management’s best estimate of the recorded reserves. Subject matter experts from underwriting and claims play an important part in informing the actuarial assumptions and methods. The governance process over the establishment of loss reserves also ensures robust considerations of the changes in the loss trends, terms and conditions, claims handling practices, and large loss impact when determining the methods, assumptions and the estimations. This multi-disciplinary process engages underwriting, claims, risk management, business unit executives and senior management and involves several iterative levels of feedback and response during the regular reserving process.
The following table summarizes the sensitivity of changes in certain assumptions in the amortization of DAC, SIA, guaranteed benefit reserves and URR, and the related hypothetical impact on year-end 2014 balances. The effect of changes in net investment spread primarily affects our Fixed Annuities product line. Changes in equity returns, volatility and interest rates primarily impact reserves for guarantee features of variable annuities in our Retirement Income Solutions and Group Retirement product lines. The effect of changes in mortality primarily impacts the universal life insurance business.
Salvage The amount that can be recovered by us for the sale of damaged goods for which our policyholder has been indemnified (and to which title was transferred to us).
Consolidated Statements of Equity for the years ended December 31, 2014, 2013 and 2012
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of American International Group, Inc.:
* Excludes gains of $2 million and $222 million in 2013 and 2012, respectively, attributable to redeemable noncontrolling interests.
Certain of our foreign subsidiaries included in the consolidated financial statements report on different annual fiscal year bases, in most cases ending November 30. The effect on our consolidated financial condition and results of operations of all material events occurring at these subsidiaries between such fiscal year end and December 31st for all periods presented in these consolidated financial statements has been recorded.
In June 2014, the FASB issued an accounting standard that changes the accounting for repurchase-to-maturity transactions and repurchase financing arrangements. It also requires additional disclosures about repurchase agreements and other similar transactions. The standard aligns the accounting for repurchase-to-maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other typical repurchase agreements such that they all will be accounted for as secured borrowings. The standard eliminates sale accounting for repurchase-to-maturity transactions and supersedes the standard under which a transfer of a financial asset and a contemporaneous repurchase financing could be accounted for on a combined basis as a forward agreement.
During the years ended December 31, 2014 and 2013, transfers into Level 3 assets primarily included certain investments in private placement corporate debt, RMBS, CMBS, CDO/ABS, and investments in hedge funds. Transfers of private placement corporate debt and certain ABS into Level 3 assets were primarily the result of limited market pricing information that required us to determine fair value for these securities based on inputs that are adjusted to better reflect our own assumptions regarding the characteristics of a specific security or associated market liquidity. The transfers of investments in RMBS, CMBS and CDO and certain ABS into Level 3 assets were due to decreases in market transparency and liquidity for individual security types. Certain investments in hedge funds were transferred into Level 3 due to these investments now being carried at fair value and no longer being accounted for using the equity method of accounting due to a change in percentage ownership, or as a result of limited market activity due to fund-imposed redemption restrictions.
Additionally, beginning in the third quarter of 2012 we elected the fair value option for certain alternative investments when such investments are eligible for this election. We believe this measurement basis is consistent with the applicable accounting guidance used by the respective investment company funds themselves. Refer to Note 6 herein for additional information.
(a) Includes certain hedge funds, private equity funds and other investment partnerships.
(b) Net of accumulated depreciation of $315 million and $513 million in 2014 and 2013, respectively.
(c) Consists primarily of investments in aircraft equipment held in consolidated trusts.
During 2014, 2013 and 2012, income recognized on investments in life settlements was $407 million, $334 million and $253 million, respectively, and is included in Net investment income in the Consolidated Statements of Income.
At December 31, 2014, management’s best estimate of the life insurance premiums required to keep the investments in life settlements in force, payable in the 12 months ending December 31, 2015 and the four succeeding years ending December 31, 2019 are $545 million, $562 million, $584 million, $607 million and $627 million, respectively.
(c) Over 99 percent of the commercial mortgages held at such respective dates were current as to payments of principal and interest.
Short-duration reinsurance is affected under reinsurance treaties and by negotiation on individual risks. Certain of these reinsurance arrangements consist of excess of loss contracts that protect us against losses above stipulated amounts. Ceded premiums are considered prepaid reinsurance premiums and are recognized as a reduction of premiums earned over the contract period in proportion to the protection received. Amounts recoverable from reinsurers on short-duration contracts are estimated in a manner consistent with the claims liabilities associated with the reinsurance and presented as a component of Reinsurance assets. Assumed reinsurance premiums are earned primarily on a pro-rata basis over the terms of the reinsurance contracts and the portion of premiums relating to the unexpired terms of coverage is included in the reserve for unearned premiums. For both ceded and assumed reinsurance, risk transfer requirements must be met for reinsurance accounting to apply. If risk transfer requirements are not met, the contract is accounted for as a deposit, resulting in the recognition of cash flows under the contract through a deposit asset or liability and not as revenue or expense. To meet risk transfer requirements, a reinsurance contract must include both insurance risk, consisting of both underwriting and timing risk, and a reasonable possibility of a significant loss for the assuming entity. Similar risk transfer criteria are used to determine whether directly written insurance contracts should be accounted for as insurance or as a deposit.
issuance and processing, and sales force contract selling. The amounts deferred are derived based on successful efforts for each distribution channel and/or cost center from which the cost originates.
DAC, VOBA and SIA for insurance-oriented and investment-oriented products are reviewed for recoverability, which involves estimating the future profitability of current business. This review involves significant management judgment. If actual future profitability is substantially lower than estimated, AIG’s DAC, VOBA and SIA may be subject to an impairment charge and AIG’s results of operations could be significantly affected in future periods.
If the qualitative test is not performed or if the test indicates a potential impairment is present, we estimate the fair value of each reporting unit and compare the estimated fair value with the carrying amount of the reporting unit, including allocated goodwill. The estimate of a reporting unit’s fair value involves management judgment and is based on one or a combination of approaches including discounted expected future cash flows, market-based earnings multiples of the unit’s peer companies, external appraisals or, in the case of reporting units being considered for sale, third-party indications of fair value, if available. We consider one or more of these estimates when determining the fair value of a reporting unit to be used in the impairment test.
At December 31, 2014, the liability for unpaid losses and loss adjustment expenses reflects a net loss reserve discount of $3.1 billion, including tabular and non-tabular calculations based upon the following assumptions:
In April 2007, the National Association of Insurance Commissioners (NAIC) formed a Settlement Review Working Group, directed by the State of Indiana, to review the Workers’ Compensation Residual Market Assessment portion of the settlement between AIG, the Office of the New York Attorney General, and the New York State Department of Insurance. In late 2007, the Settlement Review Working Group, under the direction of Indiana, Minnesota and Rhode Island, recommended that a multi-state targeted market conduct examination focusing on workers’ compensation insurance be commenced under the
Options granted under the AIG 2007 Stock Incentive Plan and the 1999 Stock Option Plan generally vested over four years (25 percent vesting per year) and expire 10 years from the date of grant. All outstanding options are vested and out of the money at December 31, 2014. There were no stock options granted since 2008. The aggregate intrinsic value for all unexercised options is zero.
(b) Total unrecognized compensation and the weighted-average period for which it will be recognized is $13 million and 0.61 year, respectively.
A Schedule 13G/A filed on February 9, 2015 reports aggregate ownership of 87,211,630 shares, or approximately 6.2 percent (based on the AIG Common Stock outstanding) of AIG Common Stock as of December 31, 2014, by various subsidiaries of Blackrock, Inc.
On January 15, 2015, we issued $1.2 billion aggregate principal amount of 3.875% Notes due 2035 and $800 million aggregate principal amount of 4.375% Notes due 2055.