We operate from approximately 180 offices in the United States and approximately 500 offices in over 70 foreign countries. The following offices are located in buildings in the United States owned by us:
In addition, our Property Casualty Insurance Companies own offices in approximately 20 foreign countries and jurisdictions including Argentina, Bermuda, Colombia, Ecuador, Japan, Mexico, the UK and Venezuela. The remainder of the office space we use is leased. We believe that our leases and properties are sufficient for our current purposes.
As of December 31, 2016, approximately 11 percent of our consolidated assets were located outside the U.S. and Canada, including $532 million of cash and securities on deposit with regulatory authorities in those locations. See Note 3 to the Consolidated Financial Statements for additional geographic information. See Note 6 to the Consolidated Financial Statements for total carrying values of cash and securities deposited by our insurance subsidiaries under requirements of regulatory authorities.
Operations outside the U.S. and Canada and assets held abroad may be adversely affected by political developments in foreign countries, including tax changes, nationalization and changes in regulatory policy, as well as by consequence of hostilities and unrest. The risks of such occurrences and their overall effect upon us vary from country to country and cannot be predicted. If expropriation or nationalization does occur, our policy is to take all appropriate measures to seek recovery of any affected assets. Certain of the countries in which our business is conducted have currency restrictions that generally cause a delay in a company’s ability to repatriate assets and profits. See Item 1A. Risk Factors - Business and Operations for additional information.
(a) Long-term debt and total liabilities include debt issuance costs of $88 million, $101 million, $81 million, $108 million, and $182 million at December 31, 2016, 2015, 2014, 2013, and 2012, respectively. See Note 2 to the Consolidated Financial Statements.
(b) Book value per common share excluding Accumulated other comprehensive income (loss) (AOCI), Book value per common share excluding AOCI and DTA (Adjusted book value per common share), Adjusted book value per common share, including dividend growth, and return on equity - after-tax operating income excluding AOCI and DTA (Adjusted return on equity) are non-GAAP financial measures and the reconciliations to the relevant GAAP financial measures are below. See
(c) Natural catastrophe losses are generally weather or seismic events having a net impact on AIG in excess of $10 million each. Catastrophes also include certain man-made events, such as terrorism and civil disorders that meet the $10 million threshold.
• actual and anticipated sales of businesses or asset divestitures or monetizations;
• strategies to increase return on equity and earnings per share;
• strategies for customer retention, growth, product development, market position, financial results and reserves; and
• our ability to successfully dispose of, or monetize, businesses or assets;
• judgments concerning estimated restructuring charges and estimated cost savings; and
We have incorporated into this discussion a number of cross-references to additional information included throughout this Annual Report to assist readers seeking additional information related to a particular subject.
Book Value Per Common Share Excluding Accumulated Other Comprehensive Income (AOCI), Book Value Per Common Share Excluding AOCI and Deferred Tax Assets (DTA) (Adjusted Book Value Per Common Share) and Adjusted Book Value Per Common Share Including Dividend Growth are used to show the amount of our net worth on a per-share basis. We believe these measures are useful to investors because they eliminate items that can fluctuate significantly from period to period, including changes in fair value of our available for sale securities portfolio, foreign currency translation adjustments and U.S. tax attribute deferred tax assets. These measures also eliminate the asymmetrical impact resulting from changes in fair value of our available for sale securities portfolio wherein there is largely no offsetting impact for certain related insurance liabilities. We exclude deferred tax assets representing U.S. tax attributes related to net operating loss carryforwards and foreign tax credits as they have not yet been utilized. Amounts for interim periods are estimates based on projections of full-year attribute utilization. As net operating loss carryforwards and foreign tax credits are utilized, the portion of the DTA utilized is included in these book value per common share metrics. Book Value Per Common Share Excluding AOCI, is derived by dividing total AIG shareholders’ equity, excluding AOCI, by total common shares outstanding. Adjusted Book Value Per Common Share is derived by dividing total AIG shareholders’ equity, excluding AOCI and DTA (Adjusted Shareholders’ Equity), by total common shares outstanding. Adjusted Book Value Per Common Share including dividend growth is derived by dividing Adjusted Shareholders’ Equity, including growth in quarterly dividends above $0.125 per share to shareholders, by total common shares outstanding. The reconciliation to book value per common share, the most comparable GAAP measure, is presented in Item 6. Selected Financial Data.
Return on Equity - After-tax Operating Income Excluding AOCI and DTA (Adjusted Return on Equity) is used to show the rate of return on shareholders’ equity. We believe this measure is useful to investors because it eliminates items that can fluctuate significantly from period to period, including changes in fair value of our available for sale securities portfolio, foreign currency translation adjustments and U.S. tax attribute deferred tax assets. This measure also eliminates the asymmetrical impact resulting from changes in fair value of our available for sale securities portfolio wherein there is largely no offsetting impact for certain related insurance liabilities. We exclude deferred tax assets representing U.S. tax attributes related to net operating loss carryforwards and foreign tax credits as they have not yet been utilized. Amounts for interim periods are estimates based on projections of full-year attribute utilization. As net operating loss carryforwards and foreign tax credits are utilized, the portion of the DTA utilized is included in Adjusted Return on Equity. Adjusted Return on Equity is derived by dividing actual or annualized after-tax operating income attributable to AIG by average Adjusted Shareholders’ Equity. The reconciliation to return on equity, the most comparable GAAP measure, is presented in Item 6. Selected Financial Data.
· uncertain tax positions and other tax items related to legacy matters having no relevance to our current businesses or operating performance.
General operating expenses, operating basis is derived by making the following adjustments to general operating and other expenses: include (i) certain loss adjustment expenses, reported as policyholder benefits and losses incurred and (ii) certain investment and other expenses reported as net investment income, and exclude (i) advisory fee expenses, (ii) non-deferrable insurance commissions, (iii) direct marketing and acquisition expenses, net of deferrals, (iv) non-operating litigation reserves and (v) other expense related to an asbestos retroactive reinsurance agreement. We use general operating expenses, operating basis, because we believe it provides a more meaningful indication of our ordinary course of business operating costs, regardless of within which financial statement line item these expenses are reported externally within our segment results. The majority of these expenses are employee-related costs. For example, other acquisition and loss adjustment expenses primarily represent employee-related costs in the underwriting and claims functions, respectively. Excluded from this measure are non-operating expenses (such as restructuring costs and litigation reserves), direct marketing expenses, insurance company assessments and non-deferrable commissions.
Operating revenues exclude Net realized capital gains (losses), income from non-operating litigation settlements (included in Other income for GAAP purposes) and changes in fair value of securities used to hedge guaranteed living benefits (included in Net investment income for GAAP purposes). Operating revenues are a GAAP measure for our operating segments.
Pre-tax operating income is derived by excluding the following items from income from continuing operations before income tax. This definition is consistent across our modules (including geography). These items generally fall into one or more of the following broad categories: legacy matters having no relevance to our current businesses or operating performance; adjustments to enhance transparency to the underlying economics of transactions; and measures that we believe to be common to the industry. PTOI is a GAAP measure for our operating segments.
· changes in fair value of securities used to hedge guaranteed living benefits;
· 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;
· other income and expense - net, related to Legacy Portfolio run-off insurance lines;
· non-qualifying derivative hedging activities, excluding net realized capital gains and losses;
· pension expense related to a one-time lump sum payment to former employees;
· restructuring and other costs related to initiatives designed to reduce operating expenses, improve efficiency and simplify our organization.
· Commercial Insurance: Liability and Financial Lines, Property and Special Risks; Consumer Insurance: Personal Insurance
- 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 (which for Commercial Insurance excludes net loss reserve discount), 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. Our ratios are calculated using the relevant segment information calculated under GAAP, and thus may not be comparable to similar ratios calculated for regulatory reporting purposes. 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.
- Accident year loss and combined ratios, as adjusted: both the accident year loss and combined ratios, as adjusted, exclude catastrophe losses and related reinstatement premiums, prior year development, net of premium adjustments, and the impact of reserve discounting. Natural catastrophe losses are generally weather or seismic events having a net impact in excess of $10 million each. Catastrophes also include certain man-made events, such as terrorism and civil disorders that meet the $10 million threshold. We believe the as adjusted ratios are meaningful measures of our underwriting results on an on-going basis as they exclude catastrophes and the impact of reserve discounting which are outside of management’s control. We also exclude prior year development to provide transparency related to current accident year results.
The estimate of the loss reserves relies on several key judgments:
· the determination of the actuarial models used as the basis for these estimates;
· the relative weights given to these models by product line;
We use numerous assumptions in determining the best estimate of reserves for each line of business. The importance of any specific assumption can vary by both line of business and accident year. Because actual experience can differ from key assumptions used in establishing reserves, there is potential for significant variation in the development of loss reserves. This is particularly true for long-tail casualty classes of business.
For our longer-tail lines, we generally make actuarial and other assumptions with respect to the following:
· Expected loss ratios are used for the latest accident year (i.e., accident year 2016 for the year-end 2016 loss reserve analysis) and, in some cases for accident years prior to the latest accident year. The expected loss ratio generally reflects the projected loss ratio from prior accident years, adjusted for the loss cost trend and the effect of rate changes and other quantifiable factors on the loss ratio. For low-frequency, high-severity lines of business such as excess casualty, expected loss ratios generally are used for at least the three most recent accident years.
We record quarterly changes in loss reserves for each product line of business. The overall change in our loss reserves is based on the sum of the changes for all product lines of business. For most long-tail product lines of business, the quarterly loss reserve changes are based on the estimated current loss ratio for each subset of coverage less any amounts paid. Also, any change in estimated ultimate losses from prior accident years deemed to be necessary based on the results of our latest detailed valuation reviews, large loss analyses, or other analytical techniques, either positive or negative, is reflected in the loss reserve for the current quarter. Differences between actual loss emergence in a given period and our expectations based on prior loss reserve estimates are used to monitor reserve adequacy between detailed valuation reviews and may also influence our judgment with respect to adjusting reserve estimates.
We conduct a comprehensive loss detailed valuation review at least annually for each product line of business in accordance with Actuarial Standards of Practice. These standards provide that the unpaid loss estimate may be presented in a variety of ways, such as a point estimate, a range of estimates, a point estimate based on the expected value of several reasonable estimates, or a probability distribution of the unpaid loss amount. Our actuarial central estimate for each product line of business represents an expected value generally considering a range of reasonably possible outcomes.
We consult with third party environmental litigation and engineering specialists, third party toxic tort claims professionals, third party clinical and public health specialists, third party workers’ compensation claims adjusters and third party actuarial advisors to help inform our judgments, as needed.
· an assessment of economic conditions including real GDP growth, inflation, employment rates or unemployment duration, stock market volatility and changes in corporate bond spreads;
· changes in medical cost trends (inflation, intensity and utilization of medical services) and wage inflation trends
· third-party claims reviews that are periodically performed for key product lines such as toxic tort, environmental and other complex casualty;
· input from underwriters on pricing, terms, and conditions and market trends; and
• Analysis of the potential for future deterioration in medical condition unlikely to be picked up by a claim file review and associated with potentially costly medical procedures (i.e., increases in both utilization and intensity of medical care) over the course of the injured worker’s lifetime;
The tail factor is typically the most critical assumption, and small changes in the selected tail factor can have a material effect on our carried reserves. For example, the tail factors beyond twenty years for guaranteed cost business could vary by one percent above or below those actually indicated in the 2016 loss reserve review. For excess of deductible business, in our judgment, it is reasonably likely that tail factors beyond twenty years could vary by five percent above or below those actually indicated in the 2016 loss reserve review.
We utilize various loss cost trend assumptions for different segments of the portfolio. After evaluating the historical loss cost trends from prior accident years since the early 1990s, in our judgment, it is reasonably likely that actual loss cost trends applicable to the year-end 2016 loss reserve review for U.S. Excess Casualty may range five percent lower or higher than this estimated loss trend. The loss cost trend assumption is critical for the U.S. Excess Casualty class of business due to the long-tail nature of the losses, and is applied across many accident years. Thus, there is the potential for the loss reserves with respect to a number of accident years (the expected loss ratio years) to be significantly affected by changes in loss cost trends that were initially relied upon in setting the loss reserves. These changes in loss trends could be attributable to changes in inflation or in the judicial environment, or in other social or economic conditions affecting losses.
The loss cost trends for U.S. D&O business vary by year and subset, but for the most recent accident years, it is assumed to have been generally close to zero. After evaluating the historical loss cost levels from prior accident years since the early 1990s, including the potential effect of losses relating to the credit crisis, in our judgment, it is reasonably likely that the actual variation in loss cost levels for these subsets could vary by approximately 15 percent lower or higher on a year-over-year basis than the assumptions actually utilized in the year-end 2016 reserve review. Because U.S. D&O business has exhibited highly volatile loss trends from one accident year to the next, there is the possibility of an exceptionally high deviation. In our analysis, the effects of loss cost trend assumptions affect the results through the a priori loss ratio assumptions used for the Bornhuetter-Ferguson and Cape Cod methods, which impact the projections for the two most recent two accident years.
U.S. Run-off Long Tail Insurance lines is an extremely long-tail class of business, with a much greater than normal uncertainty as to the appropriate loss development factors for the tail of the loss development. Specifically for excess workers’ compensation, after evaluating the historical loss development factors for prior accident years since the 1980s as well as the development over the past several years of the ground up loss projections utilized to help select the loss development factors in the tail for this class of business, in our judgment, it is reasonably likely that the tail factor beyond 30 years could vary by 10 percent above or below that actually indicated in the 2016 loss reserve review.
We determine loss adjustment expenses reserves for legal expenses for each class of business by one or more actuarial or structural driver methods. For the majority of segments, legal costs are analyzed in conjunction with losses. For segments where they are separately analyzed the methods used generally include development methods comparable to those described for loss development methods. The development could be based on either the paid loss adjustment expenses or the ratio of paid loss adjustment expenses to paid losses, or both. Other methods include the utilization of expected ultimate ratios of paid loss expense to paid losses, based on actual experience from prior accident years or from similar product lines of business.
(a) Reflects 1% tail factor change for guaranteed cost and 5% change for deductible business.
Long-duration traditional products include whole life insurance, term life insurance, accident and health insurance, long-term care insurance, and certain payout annuities for which the payment period is life-contingent, which include certain of our single premium immediate annuities and structured settlements.
Groupings for loss recognition testing are consistent with our manner of acquiring, servicing, and measuring the profitability of the business and are applied by product groupings. We perform separate loss recognition tests for traditional life products, payout annuities, and long-term care insurance. Once loss recognition has been recorded for a block of business, the old assumption set is replaced and the assumption set used for the loss recognition would then be subject to the lock-in principle. Key judgments made in loss recognition testing include the following:
• For surrender rates, a key judgment involves the correlation between expected increases/decreases in interest rates and increases/decreases in surrender rates. To support this judgment, we compare crediting rates on our products relative to expected rates on competing products under different interest rate scenarios.
Significant unrealized appreciation on investments in a prolonged low interest rate environment may cause DAC to be adjusted and additional future policy benefit liabilities to be recorded through a charge directly to accumulated other comprehensive income (“shadow loss recognition”). These charges are included, net of tax, with the change in net unrealized appreciation of 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.
Variable annuity products offered by our Individual Retirement 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) and guaranteed minimum income benefits (GMIB). See Note 14 to the Consolidated Financial Statements for additional information on these features.
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 through Policyholder benefits and losses incurred over the accumulation period based on total expected fee assessments. The liabilities for GMWB, 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 generally only receive payout from one guaranteed feature on a contract containing a death benefit and a living benefit, i.e. the features are generally mutually exclusive, so the exposure to the guaranteed amount for each feature is independent of the exposure from other features (except a surviving spouse who has a rider to potentially collect both a GMDB upon their spouse’s death and a GMWB during his or her lifetime). 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 Companies) below for sensitivity analysis which includes the sensitivity of reserves for guaranteed benefit features to changes in the assumptions for interest rates, equity market returns, volatility, and mortality. For additional discussion of market risk management related to these product features, see Enterprise Risk Management - Life Insurance Companies Key Insurance Risks - Variable Annuity Risk Management and Hedging Program.
• 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.
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 capital 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.
In estimating future gross profits for variable annuity products as of December 31, 2016, a long-term annual asset growth assumption of 7.5 percent (before expenses that reduce the asset base from which future fees are projected) was 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
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, measured as the related hypothetical impact on December 31, 2016 balances and the resulting hypothetical impact on pre-tax income, before hedging.
(a) Represents the net impact of a one percent increase or decrease in long-term equity returns for GMDB and GMIB reserves and negligible net impact of a one percent increase or decrease in the S&P 500 index for GMWB living benefit reserves.
The sensitivity ranges of 10 basis points, 1% and 10% are included for illustrative purposes only and do not reflect the changes in net investment spreads, equity return, volatility, interest rate, mortality or lapse used by AIG in its fair value analyses or estimates of future gross profits to value DAC and related reserves. Changes in excess of those illustrated may occur in any period.
At December 31, 2016, the allowance for estimated unrecoverable reinsurance was $207 million.
At each balance sheet date, we evaluate our available for sale securities holdings with unrealized losses to determine if an other-than-temporary impairment has occurred. We also evaluate our other invested assets for impairment; these include equity and cost method investments in private equity funds, hedge funds and other entities as well as investments in life settlements, aircraft and real estate.
See the discussion in Note 6 to the Consolidated Financial Statements for additional information on the methodology and significant inputs, by investment type, that we use to determine the amount of impairment.
We consider a number of factors to reliably estimate future taxable income so we can determine the extent of our ability to realize net operating losses (NOLs), foreign tax credits (FTCs), realized capital loss and other carryforwards. These factors include forecasts of future income for each of our businesses and actual and planned business and operational changes, both of which include
assumptions about future macroeconomic and AIG-specific conditions and events. We subject the forecasts to stresses of key assumptions and evaluate the effect on tax attribute utilization. We also apply stresses to our assumptions about the effectiveness of relevant prudent and feasible tax planning strategies. Our income forecasts, coupled with our tax planning strategies, all resulted in sufficient taxable income to achieve realization of the U.S. tax attributes prior to their expiration. We assess the recoverability of our net deferred tax asset related to unrealized tax capital losses in the non-life Companies’ available for sale portfolio. The deferred tax asset relates to the unrealized losses for which the carryforward period has not yet begun. As of December 31, 2016, based on all available evidence, we concluded that a valuation allowance should be established on a portion of the deferred tax asset related to unrealized losses that are not more-likely-than-not to be realized.
We separately assess the recoverability of our net deferred tax asset related to unrealized tax capital losses in the U.S. Life Insurance Companies’ available for sale portfolio. The deferred tax asset relates to the unrealized losses for which the carryforward period has not yet begun, as such when assessing its recoverability we consider our ability and intent to hold the underlying securities to recovery. As of December 31, 2016, based on all available evidence, we concluded that a valuation allowance should be established on a portion of the deferred tax asset related to unrealized losses that are not more-likely-than-not to be realized.
Our accounting for income taxes, including uncertain tax positions, represents management’s best estimate of various events and transactions, and requires judgment. FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48) (now incorporated into Accounting Standards Codification, 740, Income Taxes) prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of an income tax position taken or expected to be taken in a tax return. The standard also provides guidance on derecognition, classification, interest and penalties and additional disclosures. We determine whether it is more likely than not that a tax position will be sustained, based on technical merits, upon examination by the relevant taxing authorities before any part of the benefit can be recognized in the financial statements. A tax position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon settlement.
Since the first quarter of 2016, we have entered into or consummated the following transactions:
• In September 2016, we entered into an agreement to sell our 20 percent interest in Ascot Underwriting Holdings Ltd. and our 100 percent interest in the related syndicate-funding subsidiary Ascot Corporate Name Ltd. to Canada Pension Plan Investment Board (CPPIB). Total consideration for the transaction was $1.1 billion, inclusive of CPPIB’s recapitalization of Syndicate 1414’s Funds at Lloyd’s (FAL) capital requirements. The transaction closed on November 18, 2016, and we received approximately $244 million in net cash proceeds.
• On November 14, 2016, we entered into an agreement to sell our Japan life insurance business AIG Fuji Life Insurance Company, Ltd. (AFLI) to FWD Group, the insurance arm of Pacific Century Group.
• Effective July 1, 2016, we entered into a reinsurance agreement with Hannover Life Reassurance Company of America, involving certain whole life and universal life businesses of one of our domestic life insurance subsidiaries. This transaction uses deposit accounting for purposes of U.S. GAAP, reduced certain statutory reserves that were above economic requirements, which released excess statutory capital of approximately $1.0 billion that was included in 2016 dividend payments to AIG Parent.
• Our catastrophe reinsurance program includes coverage for natural catastrophes and some coverage for terrorism events. It consists of a large North American occurrence cover (without reinstatement) to protect against large North America losses, and Japan covers to protect against losses in Japan. Effective January 1, 2017, the attachment point for this reinsurance program is at $1.5 billion for the North American cover ($3 billion in 2016) and varies for the Japan covers. The North American cover has reduced the U.S. Hurricane (1-in-100) OEP net of reinsurance from $3.1 billion under the 2016 reinsurance program to $2.0 billion under the 2017 program.
See Notes 1, 4, 6 and 26 to the Consolidated Financial Statements for additional information on these transactions.
Decreased primarily due to adverse prior year loss reserve development in Commercial Insurance of $5.6 billion in 2016 compared to $3.3 billion in 2015.
• adverse prior year loss reserve development in Commercial Insurance of $3.3 billion in 2015 compared to $503 million in 2014;
• less favorable adjustments to reserves and DAC in Consumer Insurance, including a lower net positive adjustment to reflect the update of actuarial assumptions in Individual Retirement and additional reserves for Life Insurance as well as higher catastrophe losses and lower net favorable prior year loss reserve development in Personal Insurance; and
Declined $2.0 billion since 2014, which included a foreign exchange benefit of $0.5 billion, due to lower employee-related expenses, rationalized employee benefits and professional fee reductions related to our ongoing efficiency program.
Our business is affected by industry and economic factors such as interest rates, currency exchange rates, credit and equity market conditions, catastrophic claims events, regulation, tax policy, competition, and general economic, market and political conditions. We continued to operate under difficult market conditions in 2016, characterized by factors such as historically low interest rates, instability in the global equity markets, volatile energy markets, slowing growth in China and Euro-Zone economies, and the United Kingdom (the UK) advisory referendum in which a majority voted for the UK to withdraw its membership in the European Union (the EU) (commonly referred to as Brexit). The Brexit vote has also affected the U.S. dollar/British pound exchange rate, increased the volatility of exchange rates among the euro, British pound and the Japanese yen (the Major Currencies), and created volatility in the financial markets, which may continue for some time.
compared to 74 percent at December 31, 2015 and 79 percent at December 31, 2014. These businesses continue to focus on pricing discipline and strategies to reduce the minimum guaranteed interest crediting rates offered on new sales. In the Core universal life business in our Life Insurance segment, 70 percent of the account values were crediting at the contractual minimum guaranteed interest rate at December 31, 2016.
The impact of low interest rates on our Commercial Insurance segment is primarily on our long-tail Casualty line of business. We expect limited impacts on our existing long-tail Casualty business as the duration of our assets is slightly longer than that of our liabilities. We do expect sustained low interest rates will impact new and renewal business for the long-tail Casualty line as we may
In addition, for our Commercial Insurance segment and run-off insurance lines reported within the Legacy Portfolio, sustained low interest rates may unfavorably affect the net loss reserve discount for workers’ compensation, and to a lesser extent could favorably impact assumptions about future medical costs; the combined net effect of which could result in higher net loss reserves.
On February 3, 2017, the new administration issued a memo requiring the DOL to review the DOL Fiduciary Rule and determine whether the DOL Fiduciary Rule will adversely impact the ability of retirement savers to access information and financial advice. Accordingly, the DOL announced that it would consider legal options for postponing the applicability date of the DOL Fiduciary Rule while the DOL considers the issues raised in the referenced memo. We are closely following the DOL’s pronouncements about further delays to the DOL Fiduciary Rule’s effective date.
Liability and Financial Lines, Property and Special Risks, International Life Insurance and Personal Insurance businesses are transacted in most major foreign currencies. The following table presents the average of the quarterly weighted average exchange rates of the currencies that have the most significant impact on our businesses:
Unless otherwise noted, references to the effects of foreign exchange in the Commercial Insurance and Consumer Insurance discussion of results of operations are with respect to movements in the three Major Currencies included in the preceding table.
The following table presents our consolidated results of operations and other key financial metrics:
The following table presents a reconciliation of General operating and other expenses to General operating expense, operating basis, which is a Non-GAAP measure:
Pension expense related to a one-time lump sum payment to former
* For 2016, because we reported a net loss, all common stock equivalents are anti-dilutive and are therefore excluded from the calculation of diluted shares and diluted per share amounts. However, because we reported after-tax operating income, the calculation of after-tax operating income per diluted share includes 30,326,772 dilutive shares.
• adverse prior year loss reserve development in Commercial Insurance of $5.6 billion in 2016 compared to $3.3 billion in 2015; and
• net realized losses compared to net realized gains in the prior-year period due to:
· lower general operating expenses reflecting strategic actions to reduce expenses;
· adverse prior year loss reserve development in Commercial Insurance of $3.3 billion in 2015 compared to $503 million in 2014;
• lower income from divested businesses as a result of the sale of ILFC in the second quarter of 2014.
• a lower loss on extinguishment of debt from ongoing liability management activities;
- higher net realized capital gains from sales of investments, which included realized gains on the sales of Class B shares of Prudential Financial, Inc., a portion of our holdings in People’s Insurance Company (Group) of China Limited and PICC Property & Casualty Company Limited (collectively, our PICC Investment), and common shares of OneMain Holdings, Inc., mostly offset by a realized loss on the sale of ordinary shares of AerCap and an increase in other-than-temporary impairment charges.
For the year ended December 31, 2016, the effective tax rate on loss from continuing operations was not meaningful. The effective tax rate on loss from continuing operations differs from the statutory tax rate of 35 percent primarily due to
- $164 million associated with a portion of the U.S. Life Insurance Companies capital loss carryforwards previously treated as expired that was restored and utilized,
For the year ended December 31, 2015, the effective tax rate on income from continuing operations was 32.3 percent. The effective tax rate on income from continuing operations differs from the statutory tax rate of 35 percent primarily due to tax benefits of $195 million associated with tax exempt interest income, $127 million related to reclassifications from accumulated other comprehensive income to income from continuing operations related to the disposal of available for sale securities, $58 million associated with the effect of foreign operations, and $109 million related to the partial completion of the IRS examination covering tax year 2006, partially offset by $324 million of tax charges and related interest associated with increases in uncertain tax positions related to cross border financing transactions, and $110 million related to increases in the deferred tax asset valuation allowances associated with certain foreign jurisdictions. See Note 23 to the Consolidated Financial Statements for additional information.
For the year ended December 31, 2014, the effective tax rate on income from continuing operations was 27.9 percent. The effective tax rate on income from continuing operations differs from the statutory tax rate of 35 percent primarily due to tax benefits of $236 million associated with tax exempt interest income, $209 million related to a decrease in the U.S. Life Insurance Companies’ capital loss carryforward valuation allowance, $182 million of income excludible from gross income related to the global resolution of certain residential mortgage-related disputes and $68 million associated with the effect of foreign operations.
We modified the presentation of our segment results in 2016 to reflect our new operating structure and prior periods’ presentation has been revised to conform to the new structure.
Financial Lines: Products include professional liability insurance for a range of businesses and risks, including directors and officers liability (D&O), mergers and acquisitions (M&A), fidelity, employment practices, fiduciary liability, cyber risk, kidnap and ransom, and errors and omissions insurance (E&O).
Drive Efficiency: Reorganized our operating model into “modular”, business units with greater end-to-end accountability, transparency, and strategic flexibility, enhancing decision making and driving performance improvement over time; increase capital fungibility and diversification; streamline our legal entity structure; optimize reinsurance; improve tax efficiency and reduce expenses.
Invest to Grow: Grow our higher-value businesses while investing in transformative opportunities, continuing initiatives to modernize our technology and infrastructure, advancing our engineering capabilities, innovating new products and client risk services and delivering a better client experience.
• information technology infrastructure modernization, which puts pressure on our efforts to reduce operating expenses;
• long-tail exposures create added challenges to pricing and risk management;
We have observed an increase in frequency of severity of losses, particularly in Auto, which is impacting not only the primary books, but also having leverage impacts on excess layers. Loss cost trend rates across U.S. casualty lines in general are increasing with the exception of U.S. workers’ compensation. The market is still challenging in terms of the level of capacity, which is continuing to impact the rate environment. The overall rates we have achieved have been positive across most business lines (in particular in auto where we have seen a large number of double digit increases as we have remediated underpriced business through a combination of product exits and use of reinsurance). The current accident year deterioration has seen partial offsets as a result of actions taken in 2016 to grow higher value lines such as M&A and Cyber.
In 2016, Property and Special Risks experienced growth in certain strategic high value businesses that led to positive results that met or exceeded our expectations, including U.S. middle market property, and we expect such growth to continue in 2017. The U.S. large limit property business continues to be a profitable investment area, and remains at volumes consistent with 2015. Property and Special Risks also expects that expansion in certain growth economies will continue at a faster pace than in developed countries, but at levels lower than those previously expected due to revised economic assumptions. Rates in more commoditized lines of business such as U.S. Excess and Surplus lines continue to be unsatisfactory and we intend to continue to reduce our net premiums written in these areas.
Overall, Property and Special Risks experienced rate pressure in 2016, which is expected to continue in the near term, particularly in the U.S. and Europe. Property and Special Risks continues to differentiate its underwriting capacity from its peers by leveraging its global footprint, diverse product offering, risk engineering expertise and significant underwriting experience.
Primarily due to reductions in the Property portfolio driven by actions to address accounts with inadequate price and/or terms and conditions, catastrophe exposures have declined.
(a) Consistent with our definition of Pre-tax operating income, excludes loss reserve discount.
As discussed in the Executive Summary, in January 2017, we entered into an adverse development reinsurance agreement with NICO, which covers 80 percent of up to $9 billion of potential future prior year development on substantially all of our U.S. Casualty and Financial Lines exposures for accident years 2015 and prior. Under U.S. GAAP, any potential future prior year development would be recognized immediately as losses are incurred; however, the related recoveries under the reinsurance agreement would be deferred and recognized over the expected recovery period.
• higher adverse prior year reserve development (increase by $1.8 billion);
• lower net premiums earned primarily driven by reinsurance and portfolio optimization; and
• lower general operating expenses primarily due to lower employee-related expenses and other expense reduction initiatives; and
• lower acquisition expenses primarily due to the ceding commissions related to the reinsurance arrangement with Swiss Re Group which became effective in the first quarter of 2016.
• lower net investment income driven by lower income on alternative investments as well as lower return on assets due to decreases in interest rates.
• lower general operating expenses primarily due to lower employee-related expenses resulting from actions to streamline our management structure and general cost containment measures commenced in 2015; and
• lower new and renewal business reflecting efforts to adhere to underwriting discipline in the current competitive environment; and
• the renewal of a multi-year E&O policy in the U.S. in 2015.
- continued execution of our strategy to enhance our portfolio mix, including reduced production in certain underperforming products such as excess casualty; and
- higher renewal retention on growth products such as cyber and M&A; and
- renewal of a multi-year E&O policy in the U.S. in the first quarter of 2015.
• lower acquisition expense ratio driven by higher commission income through new reinsurance transactions.
• an increase in the loss ratio partially offset by a decrease in the expense ratio.
• reserve strengthening primarily in U.S. Excess casualty as well as Financial lines; and
• higher accident year loss ratio, as adjusted, driven by Casualty.
• decreases in the general operating expense ratio due to our ongoing focus on cost efficiency; and
The net premiums written decrease in 2016 was driven by portfolio optimization and continued challenging market conditions, coupled with a decrease of assumed premiums related to the 50 percent quota share reinsurance agreement with United Guaranty. This quota share reinsurance agreement contributed $146 million and $86 million to pre-tax operating income in 2016 and 2015, respectively. The increase in net losses and loss ratio were driven by higher catastrophes and higher net adverse prior year loss reserve development, partially offset by lower severe losses. The expense ratio increase was mainly driven by business mix shift and premium reduction, which more than offset expense reduction. Lower net investment income was driven primarily by lower alternative investment returns due to weaker performance in equity markets compared to prior years.
• higher adverse prior year development primarily due to an increase in the U.S. Programs business;
• lower net investment income due to lower income on alternative investments.
• the effect of the 50 percent quota share reinsurance agreement with UGC; and
• slightly lower general operating expenses primarily due to lower employee-related expenses and other expense reduction initiatives.
• higher acquisition other expenses due to an increase in net commission expenses in certain classes of businesses, as well as higher premium taxes and other assessments reflecting changes in the business mix; and
• continued execution of our strategy to optimize our portfolio mix;
• increases in rate pressure, significant competition and challenging market conditions;
• lower premiums related to the 50 percent quota share reinsurance agreement with UGC.
• reduced production in certain products due to enhanced risk selection.
The decrease in both loss ratio and accident year loss ratio, as adjusted, reflected:
• higher acquisition ratio due to an increase in net commission expenses in certain classes of businesses, as well as higher premium taxes and other assessments reflecting change in business mix; and
• partially offset by lower general operating expense ratio due to lower employee-related expenses, and other expense reduction initiatives.
Index Annuities: Products include fixed index annuities that provide growth potential based in part on the performance of a market index. Certain fixed index annuity products offer optional income protection features. Fixed index annuities are distributed primarily through banks, broker dealers, independent marketing organizations and independent insurance agents.
Products and services are marketed by the Variable Annuity Life Insurance Company (VALIC) under the VALIC brand and include investment offerings and plan administrative and compliance services. VALIC career financial advisors and independent financial advisors provide retirement plan participants with enrollment support and comprehensive financial planning services.
Life Insurance: In the U.S., primarily includes term life and universal life insurance. International operations include the distribution of life and health products in the UK and Ireland. Life products in the U.S. are primarily distributed through independent marketing organizations, independent insurance agents, financial advisors and direct marketing.
Group: Products include voluntary and sponsor-paid personal accident and supplemental health products for individuals, employees, associations and other organizations, a broad range of travel insurance products and services for leisure and business travelers as well as extended warranty insurance covering electronics, appliances, and HVAC industries. Products are distributed through various channels, including agents, brokers, affinity partners, airlines and travel agents.
Sharpen Consumer Focus: Invest in areas where Consumer Insurance can grow profitability and sustainably, and achieve and maintain industry leading positions. Narrow Consumer Insurance’s footprint in less profitable markets with insufficient scale.
Consumer Insurance operates in the highly competitive insurance and financial services industry in the U.S. and select international markets and competes against various financial services companies, including mutual funds, banks and other life and property casualty insurance companies. Competition is primarily based on product pricing and design, distribution, financial strength, customer service and ease of doing business.
· increasingly complex new and proposed regulatory requirements have created uncertainty that is affecting industry growth; and
· investments to upgrade our technology and underwriting processes challenge our management of general operating expenses.
Group Retirement competes in the defined contribution market under its VALIC brand. VALIC is a leading retirement plan provider in the U.S. for K-12 schools and school districts, higher education, healthcare, government and other not-for-profit institutions. The defined contribution market is a highly efficient and competitive market that requires support for both plan sponsors and individual participants. To meet this challenge, VALIC is investing in a client-focused technology platform to support improved compliance and self-service functionality. VALIC’s service model pairs self-service tools with its career financial advisors who provide individual plan participants with enrollment support and comprehensive financial planning services.
The need for full life cycle products and coverage, increases in personal wealth accumulation, and awareness of insurance protection and risk management continue to support the growth of the Personal Insurance industry. Personal Insurance focuses on group and corporate clients, together with individual customers within national markets. We expect the demand for multinational cross-border coverage and services to increase due to the internationalization of clients and customers. We believe our global presence provides Personal Insurance a distinct competitive advantage.
The Individual Retirement, Group Retirement and Life Insurance modules review and update estimated gross profit assumptions used to amortize deferred policy acquisition costs (DAC) and related items for investment-oriented products, as well as other actuarial assumptions, at least annually. As a result, the pre-tax operating earnings of these businesses include adjustments to policy fees, policyholder benefits, interest credited and DAC amortization to reflect such assumption updates, which may be significant. See Insurance Reserves - Life and Annuity Reserves and DAC - Update of Actuarial Assumptions for the amount of adjustments recorded to reflect such assumption updates in 2016, 2015 and 2014 by product line and financial statement line item and for related discussion of the assumption changes that resulted in these adjustments.
A diverse product portfolio enabled Individual Retirement to maintain industry-leading positions in annuity sales despite a challenging environment, which included an industry-wide slowdown primarily driven by uncertainty about the DOL Fiduciary Rule, compared to strong Variable and Index Annuity sales growth in 2015 and 2014. Our total sales of Index Annuities slowed in 2016 but continued to outpace the industry. Fixed Annuities sales increased in 2016 as customers chose the safety of fixed returns in a period of equity volatility, but the sustained low interest rate environment, together with aggressive pricing by private equity-backed annuity writers, resulted in a modest decline in market share in 2016 and negative net flows for Fixed Annuities in 2016, 2015 and 2014. Reinvestment in the low interest rate environment contributed to spread compression in Fixed Annuities, and net investment income results included volatility from alternative investments, mortgage loan prepayments, and fair value option assets. Pre-tax operating income also included adjustments in each year to update actuarial assumptions, particularly from lower surrenders across all product lines. Excluding such adjustments, net growth in average assets for Variable and Index Annuities drove higher fee income, partially offset by increased DAC amortization. The sale of AIG Advisor Group in May 2016 resulted in decreases in advisory fee income, advisory fee expense and general operating expenses in 2016 compared to 2015, but did not result in a significant decrease in pre-tax operating income.
Pre-tax operating income increased in 2016 compared to 2015 primarily due to:
• higher policy fee income due to growth in annuity account values from positive net flows; and
• lower net investment income due to lower returns on alternative investments in hedge funds and lower base net investment income primarily due to reinvestment in the low interest rate environment;
• a lower net positive adjustment from the review and update of actuarial assumptions, which was $92 million in 2015 compared to $200 million in 2014;
• higher DAC amortization in Variable and Index Annuities due to growth in the business and lower equity market returns; and
• higher general operating expenses due in part to technology investments and higher expenses associated with continued strong sales in Variable and Index Annuities.
These decreases were partially offset by higher policy fee income due to growth in annuity account values.
Net flows for annuity products in Individual Retirement represent premiums and deposits less death, surrender and other withdrawal benefits. Net flows for mutual funds represent deposits less withdrawals.
Individual Retirement annuities are typically subject to a four- to seven-year surrender charge period, depending on the product. The increase in the amount and proportion of annuity reserves that have no surrender charge at December 31, 2016 compared to December 31, 2015 was primarily due to normal aging of this book of business, as well as lower than expected surrenders of older contracts with higher minimum interest rates on fixed account balances that have continued to be attractive to the contract holders in the low interest rate environment. For Variable and Index Annuities, the increase in reserves with higher surrender charges during these periods was due to positive net flows from these product lines during 2016. The increase in the amount of reserves within the surrender charge period, as well as uncertainty around the DOL Fiduciary Rule, drove the improvement in the surrender rate in 2016 and 2015.
A discussion of the significant variances in premiums and deposits and net flows for each product line follows:
• Fixed Annuities deposits increased in 2016 primarily due to higher sales in the bank and broker-dealer distribution channels as a result of customers favoring the safety of fixed annuities in response to equity market volatility. Net flows were negative in 2016, but improved compared to 2015 due to higher sales.
• Fixed Annuities premiums and deposits increased in 2015 due to new product offerings and increases in market interest rates driven by widening credit spreads in the second half of the year, while net flows continued to be negative, primarily due to the sustained relatively low interest rate environment.
• Retail Mutual Funds deposits increased in 2015, driven primarily by activity within the Focused Dividend Strategy Portfolio fund. In 2015, sales and withdrawals for this fund improved compared to a decline in 2014, due to a return to strong performance levels, which drove the growth in Retail Mutual Funds net flows.
Pre-tax operating income decreased in 2016 compared to 2015 primarily due to:
These decreases were partially offset by lower general operating expenses due to reductions in employee-related expenses.
• higher DAC amortization (excluding adjustments to reflect assumption updates) due to higher run rate from assumptions updated in the prior year; and
• lower policy fee income due to a decrease in separate account assets, which reflected negative net flows.
• lower policyholder benefits due to favorable mortality on immediate annuities; and
Group Retirement GAAP Premiums, Premiums and Deposits, Surrenders and Net Flows
For Group Retirement, premiums primarily represent amounts received on life-contingent payout annuities. Premiums increased in 2016 compared to 2015, as customers continued to invest in immediate annuities due to equity market volatility. Premiums decreased in 2015 compared to 2014, primarily due to lower interest rates.
Net flows for annuity products included in Group Retirement represent premiums and deposits less death, surrender and other withdrawal benefits. Net flows for mutual funds represent deposits less withdrawals.
The following table presents a reconciliation of Group Retirement premiums and deposits to GAAP premiums:
(b) Group Retirement amounts in this category include reserves of approximately $6.3 billion and $6.2 billion, at December 31, 2016 and 2015, respectively, that are subject to 20 percent annual withdrawal limitations.
A discussion of the significant variances in premiums and deposits and net flows follows:
Net flows improved significantly due to both record deposits in 2016 and improved surrender activity, which included group plan surrenders of approximately $631 million in 2016 compared to $1.5 billion in 2015. The group plan market has been impacted by the consolidation of healthcare providers and other employers in target markets, but group plan acquisitions improved in 2016 compared to 2015, due in part to investments in talent, group plan administration record-keeping capabilities and digital functionality.
Pre-tax operating loss in 2016 improved compared to 2015 primarily due to:
• lower net investment income on alternative investments, largely offset by higher other enhancement income, primarily bond call and tender income;
• underperforming group benefits results, including reserve increases and elevated morbidity experience;
• higher international general operating expenses, due in part to the acquisition in March 2015 of Laya Healthcare, an Irish healthcare distributor and administrator, and
• international pre-tax operating losses in 2015, including higher general operating expenses, related to the expansion through the acquisitions of AIG Life Limited and Laya Healthcare. The increase in expenses from these acquisitions was partially offset by domestic savings from organizational changes.
Premiums for Life Insurance represent amounts received on traditional life insurance policies, primarily term life, and group benefit policies. Premiums increased 9 percent in 2016 compared to 2015 and increased 8 percent in 2015 compared to 2014, excluding the effect of foreign exchange, primarily due to growth in international life and health, including the December 2014 acquisition of AIG Life Limited in the UK.
Premiums and deposits grew by 5 percent in 2016 compared to 2015, and increased by 6 percent in 2015 compared to 2014, excluding the effect of foreign exchange, principally driven by growth in international life and health sales from the acquisition of AIG Life Limited and assumed premiums related to business distributed by Laya Healthcare.
Adjustments for accident year loss ratio, as adjusted, and accident year combined ratio, as adjusted:
The following table presents Personal Insurance net premiums written, showing change on both reported and constant dollar basis:
(a) Geography shown in the table represents where the ultimate liability resides, after intercompany reinsurance agreements, and is not necessarily indicative of where the catastrophe or severe loss events have occurred. This presentation follows our geography modules. See Item 1. Business for further discussion on our geography modules.
(c) Severe losses are defined as non-catastrophe individual first party losses and surety losses greater than $10 million, net of related reinsurance and salvage and subrogation.
Personal Insurance operating results improved significantly in 2016 compared to 2015 and 2014, driven by the effective execution of strategic and portfolio actions to reduce total expenses, including refocusing direct marketing activities, while continuing underwriting actions and maintaining pricing discipline. In addition, while market competition in the personal insurance industry has intensified, the year-over-year stability of loss ratio and accident year loss ratio, as adjusted, reflected the underwriting quality, portfolio diversity, and low volatility of short-tailed risk in our Personal Insurance book.
• lower net investment income reflecting reduced income on alternative investments; and
• decreased production in Accident and Health primarily due to continued underwriting actions to strengthen our portfolio and maintain pricing discipline, with lower sales as a result of refocusing our direct marketing activities; and
• decreased production in personal property primarily due to the impact of a duration restriction on long-term fire insurance put in place in the fourth quarter of 2015 in Japan, partially offset by new business growth in the AIG Private Client Group (AIG PCG) business.
Net premiums written decreased on a reported basis. Net premiums written increased excluding the effect of foreign exchange. The increase in net premiums written on a constant dollar basis was due to the following:
• increased production in Accident and Health primarily due to a sales increase in Japan, partially offset by a decrease in the U.S., due to continued underwriting discipline;
• increased production in personal property attributable to new business sales and improved retention in AIG PCG;
• increase in Japan new housing starts and heightened demand before the duration restriction on long-term fire insurance became effective in October 2015; and
• retention of more favorable risks in U.S. personal property through optimization in reinsurance structure, while continuing to manage aggregate exposure.
• a decrease in loss ratio primarily due to higher net favorable prior year loss reserve development.
• higher severe losses and higher number of large but not severe losses in the U.S. personal property business.
• higher investment in strategic initiatives and technology-related expenses, partially offset by ongoing focus on cost efficiency.
Pre-tax operating loss before eliminations decreased primarily due to lower Parent and Other corporate general operating expenses and interest expense. Parent and Other general operating expenses decreased in 2015 due to a $175 million pension curtailment credit. Parent and Other interest expense decreased primarily as a result of liability management activities.
Pre-tax operating income of United Guaranty decreased primarily as a result of the 50 percent quota share reinsurance agreement between United Guaranty and our subsidiaries for business originated from 2014 to 2016.
Pre-tax operating income of Institutional Markets decreased primarily due to a reserve release in 2014 and lower net investment income, which reflected lower returns on alternative investments in hedge funds.
Legacy Life Insurance Run-Off Lines - include whole life, long term care and exited Accident & Health product lines. Also includes certain structured settlement, terminal funding and single premium immediate annuities written prior to April 2012.
• Third party and affiliated reinsurance and retrocessions to improve capital efficiency
For Legacy Investments, our business strategy is to maximize liquidity to AIG Parent and minimize book value impairments while sourcing for our insurance companies attractive assets for their portfolios. Where the asset is under AIG’s sole control, we expect to achieve this through a combination of unaffiliated and affiliated sales and securitizations. Where the asset is not under AIG’s sole control, AIG has fewer options as we may, for example, have fiduciary duty obligations to joint venture partners (such as in our Legacy Global Real Estate book).
• On November 17, 2016, an AIG sponsored Fund (the Korea Fund) completed the sale of a mixed-use commercial complex in Seoul, South Korea commonly known as the Seoul International Finance Center, to Brookfield Properties for total consideration of $2.5 billion, of which $1.2 billion was used to repay the fund’s debt. The remaining cash proceeds were allocated between AIG and the noncontrolling interests in accordance with the Korea Fund’s partnership agreement.
• On December 30, 2016, we sold a portion of our life settlements portfolio with face value (death benefits) of approximately $4.5 billion.
• For certain attractive, high-yielding assets, a series of internal securitizations were completed with the insurance companies over the last two years.
In addition, the Legacy Run-Off Insurance business distributed to AIG Parent approximately $1.1 billion in the form of dividends and tax sharing payments resulting from reinsurance transactions. These transactions have helped to reduce the relative size of the Legacy portfolio.
• lower Legacy Life earnings in 2016 compared to 2015 primarily due to lower net investment income on investments and higher loss recognition on certain payout annuities from the update of actuarial assumptions;
• higher Legacy Investment pre-tax operating income driven mainly by asset sales, partially offset by fair value losses on certain investments.
• lower Legacy Life earnings in 2015 compared to 2014 primarily due to lower returns on alternative investments in hedge funds and lower bond call and tender income. This was partially offset by a $20 million reduction in the reserve for IBNR death claims related to enhanced claims practices, compared with a $104 million increase in this reserve in 2014;
• lower Legacy Property and Casualty pre-tax operating income driven primarily by higher underwriting losses due to an increase in net adverse prior year loss reserve development; and
• lower Legacy Investment pre-tax operating income driven primarily by lower appreciation on assets for which the fair value option was elected and lower fair value income on derivative positions.
• We continued to make investments in structured securities and other fixed maturity securities and increased lending activities in mortgage loans with favorable risk versus return characteristics to improve yields and increase net investment income.
• During 2016, we reduced our hedge fund portfolio by $3.2 billion as a result of redemptions consistent with our planned reduction of exposure. Our alternative investments portfolio performance also experienced a decline in 2016 due to increased volatility in equity markets, primarily in the first quarter of 2016.
• Other-than-temporary impairments decreased due to lower impairments in our equity securities, available for sale.
• We recognized gains on sales of securities in 2016, primarily due to the sale of a portion of our PICC Investment.
Investment strategies are based on considerations that include the local and general market conditions, liability duration and cash flow characteristics, rating agency and regulatory capital considerations, legal investment limitations, tax optimization and diversification.
(a) Beginning in the first quarter of 2016, the presentation of income on alternative investments has been refined to include only income from hedge funds, private equity funds and affordable housing partnerships. Prior period disclosures have been reclassified to conform to this presentation. Hedge funds for which we elected the fair value option are recorded as of the balance sheet date. Other hedge funds are generally reported on a one-month lag, while private equity funds are generally reported on a one-quarter lag.
Net investment income decreased for 2015 compared to 2014 due to lower income on alternative investments, primarily related to hedge fund performance, lower income on assets for which the fair value option was elected, and lower reinvestment yields.
For the Property Casualty Insurance Companies, the duration of liabilities for long-tail casualty lines is greater than that of other lines. As a result, the investment strategy within the Property Casualty Insurance Companies focuses on growth of surplus and preservation of capital, subject to liability and other business considerations.
The Property Casualty Insurance Companies invest primarily in fixed maturity securities issued by corporations, municipalities and other governmental agencies and also invest in structured securities collateralized by, among other assets, residential and commercial real estate and commercial mortgage loans. While invested assets backing reserves of the Property Casualty Insurance Companies are primarily invested in conventional fixed maturity securities, we have continued to allocate a portion of our investment activity into asset classes that offer higher yields, particularly in the domestic operations. In addition, we continue to invest in both fixed rate and floating rate asset-backed investments for their risk-return attributes, as well as to manage our exposure to potential changes in interest rates. This asset diversification has maintained stable average yields while the overall credit ratings of our fixed maturity securities were largely unchanged. We expect to continue to pursue this investment strategy to meet the Property Casualty Insurance Companies’ liquidity, duration and credit quality objectives as well as current risk-return and tax objectives.
In addition, the Property Casualty Insurance Companies seek to enhance returns through selective investments in a diversified portfolio of alternative investments. Although these alternative investments are subject to periodic earnings fluctuations, they have historically achieved yields in excess of the fixed maturity portfolio yields and have provided added diversification to the broader portfolio.
Fixed maturity investments of the Property Casualty Insurance Companies domestic operations, with an average duration of 4.7 years, are currently comprised primarily of tax-exempt securities, which provide attractive risk-adjusted after-tax returns, as well as
taxable municipal bonds, government and agency bonds, and corporate bonds. The majority of these high quality investments are rated A or higher based on composite ratings.
The Life Insurance Companies use asset-liability management as a primary tool to monitor and manage risk in their businesses. The Life Insurance Companies' fundamental investment strategy is to maintain a diversified, high quality portfolio of fixed maturity securities that, to the extent practicable, complements the characteristics of liabilities, including duration, which is a measure of sensitivity to changes in interest rates. The investment portfolio of each product line is tailored to the specific characteristics of its insurance liabilities, and as a result, certain portfolios are shorter in duration and others are longer in duration. An extended low interest rate environment may result in a lengthening of liability durations from initial estimates, primarily due to lower lapses, which may require us to further extend the duration of the investment portfolio.
In addition, the Life Insurance Companies seek to enhance returns through investments in a diversified portfolio of alternative investments. Although these alternative investments are subject to periodic earnings fluctuations, they have historically achieved yields in excess of the fixed maturity portfolio yields. While a diversified portfolio of alternative investments remains a fundamental component of the investment strategy of the Life Insurance Companies, we intend to reduce the overall size of the hedge fund portfolio, in light of changing market conditions and perceived market opportunities, and to continue reducing the size of the private equity portfolio.
The following table presents the fixed maturity security portfolio of U.S. Insurance Companies categorized by NAIC Designation, at fair value:
* Excludes $23.9 billion of fixed maturity securities for which no NAIC Designation is available because they are held in legal entities within U.S. Insurance Companies that do not require a statutory filing.
At December 31, 2016, approximately 92 percent of our fixed maturity securities were held by our domestic entities. Approximately 17 percent of these securities were rated AAA by one or more of the principal rating agencies, and approximately 17 percent were rated below investment grade or not rated. Our investment decision process relies primarily on internally generated fundamental analysis and internal risk ratings. Third-party rating services’ ratings and opinions provide one source of independent perspective for consideration in the internal analysis.
Our investments in the energy category, as a percentage of total investments in available-for-sale fixed maturities, were 5.6 percent at both December 31, 2016 and December 31, 2015. While the energy investments are primarily investment grade and are actively managed, the category continues to experience volatility that could adversely affect credit quality and fair value.
The following table presents AIG’s RMBS available for sale investments by year of vintage:
At December 31, 2016, we had direct commercial mortgage loan exposure of $25.0 billion, of which 100 percent of the loans were current.
Impairments on Life Settlements in 2016 were partially attributable to an increase in policy premiums required to keep policies in force which resulted in lower future expected net cash flows which were insufficient to recover our net investment on certain policies.
Impairments on Life Settlements in 2015 were partially attributable to an increase in policy premiums required to keep policies in force which resulted in lower future expected net cash flows which were insufficient to recover our net investment on certain policies as well as our adoption of the Society of Actuaries 2015 Valuation Basic Table (VBT) as the market mortality assumption used to measure the fair value of impaired policy.
The change in net unrealized gains and losses on investments in 2016 was primarily attributable to increases in the fair value of fixed maturity securities. For 2016, net unrealized gains related to fixed maturity and equity securities increased by $0.9 billion due primarily to a narrowing of credit spreads, which more than offset the rise in rates.
Net realized capital gains in 2015 were primarily driven by foreign exchange gains which included $243 million of gains in 2015, related to the intercompany notional cash pooling arrangement, discussed above and net gains on the sales of various securities such as the Class B shares of Prudential Financial, Inc., common shares of OneMain Holdings and sales of our PICC Investment. These realized gains were partially offset by realized losses related to the sale of ordinary shares of AerCap.
(b) Includes loss reserve discount of $3.6 billion and $3.1 billion for the years ended December 31, 2016, and 2015, respectively. See Note 13 to the Consolidated Financial Statements for discussion of loss reserve discount.
As discussed more fully below, in 2016, we recognized adverse prior year loss reserve development of $5.8 billion, primarily as a result of the following:
As discussed above, we observed higher than expected loss emergence in several casualty classes as follows:
• U.S. Other Casualty - Primary general liability 21 percent greater than expected
• U.S. Other Casualty - Medical Malpractice 16 percent greater than expected
Our analyses and conclusions about prior year reserves also help inform our judgments about the current accident year loss and loss adjustment expense ratios we select. In 2016, we increased our selections in the third quarter and again in the fourth quarter. The effect of these increases on year-to-date premiums resulted in a $700 million increase in net losses incurred.
In the tables below, we present prior year development in accident year groupings of 2005 and prior, 2006 - 2010 and 2011 - 2015. The grouping 2005 and prior represents the period ending with the 2005 restatement of our consolidated financial statements. The period 2006 - 2010 includes the years leading up to and immediately following the financial crisis. The period in 2011 - 2015 includes the periods during which we completed the recapitalization of AIG and began exiting U.S. Government ownership which was completed in 2012.
See Note 13 to the Consolidated Financial Statements for further details of prior year development by line of business. See also Critical Accounting Estimates for a discussion of actuarial methods employed for major classes of business.
• Accident years 2011 to 2015 - adverse development of $3.1 billion were primarily driven by U.S. Other Casualty (commercial automobile liability, general liability and medical malpractice), U.S. Excess Casualty, U.S. Workers’ Compensation, and U.S. Special Risks programs business. As discussed more fully in Note 13 to the Consolidated Financial Statements these lines experienced adverse actual versus expected loss activity and higher loss trends, and we responded by increasing our expected loss development tail factors.
• Accident years 2005 and prior - adverse development of $1.3 billion was driven by increased loss development factors in U.S. Workers’ Compensation and U.S. Other Casualty general liability.
• Accident years 2006 to 2010 - adverse development of $846 million were largely impacted by updated loss development selections in U.S. Financial Lines and revised estimates on expected future recoveries from risk-sharing policies in the U.S. Workers’ Compensation business.
• Accident years 2006 to 2010 - adverse development of $2 million were driven by U.S. Financial lines and U.S. Excess Casualty.
For certain categories of claims (e.g., construction defect claims and environmental claims) and for reinsurance recoverable, losses may sometimes be reclassified to an earlier or later accident year as more information about the date of occurrence becomes available to us. These reclassifications are shown as development in the respective years in the tables above. This may affect the comparability of the data presented in our tables.
Effective January 1, 2016, we entered into a two-year reinsurance arrangement with the Swiss Reinsurance Company Ltd, under which we ceded a proportional share of our new and renewal U.S. Casualty portfolio in order to reduce the concentration of casualty business in our portfolio.
On January 20, 2017, we entered into an adverse development reinsurance agreement with NICO, a subsidiary of Berkshire Hathaway Inc., under which we transferred to NICO 80 percent of the reserve risk on substantially all of our U.S. Commercial long-tail exposures for accident years 2015 and prior. Under this agreement, we ceded to NICO 80 percent of the paid losses on subject business paid on or after January 1, 2016 in excess of $25 billion of net paid losses, up to an aggregate limit of $25 billion. At NICO’s 80 percent share, NICO’s limit of liability under the contract is $20 billion. We will account for this transaction as retroactive reinsurance. The consideration for this agreement is $9.8 billion plus interest at 4 percent per annum from January 1, 2016 to date of payment, which was paid in full as of February 17, 2017. The consideration paid to NICO will be placed into a collateral trust account as security for NICO’s claim payment obligations, and Berkshire Hathaway Inc. has provided a parental guarantee to secure the obligations of NICO under the agreement.
The following table calculates the amount of the deferred gain expected to be recorded in the first quarter of 2017, on a nominal and net basis and showing the effect of discounting of loss reserves, using the reserve position of December 31, 2016. The stated effective date of the agreement is January 1, 2016, and therefore losses paid on subject business during 2016 are included in the calculation. The deferred gain will be amortized over the settlement period of the reinsured losses.
The lines of business subject to this agreement have been the source of substantially all of the prior year adverse development charges over the past several years. The agreement is expected to result in lower capital charges for reserve risks at our U.S. insurance subsidiaries. Under U.S. GAAP, any potential future prior year development would be recognized immediately as losses are incurred; however, the related recoveries under the reinsurance agreement would be deferred and recognized over the expected recovery period. In addition, we would expect future net investment income to decline as a result of lower invested assets.
The update of actuarial assumptions in 2016, 2015 and 2014 included adjustments for products now reported in the Legacy Portfolio, primarily loss recognition expense related to pre-2010 payout annuities and certain long-term care products. Assumptions related to investment yields, mortality experience and expenses for long-duration traditional products are reviewed periodically and updated as appropriate, which could result in additional loss recognition reserves.
The following table presents the increase (decrease) in pre-tax operating income resulting from the update of actuarial assumptions for the domestic life insurance companies, by segment and product line:
Total increase (decrease) in pre-tax operating income from update of assumptions
In 2016, pre-tax operating income included a net negative adjustment of $384 million, primarily driven by $622 million of loss recognition reserves for pre-2010 payout annuities in the Legacy Portfolio, and an increase in Life Insurance reserves for universal life with secondary guarantees. These negative adjustments were partially offset by positive adjustments, primarily lower surrender assumptions in Fixed Annuities.
In 2014, pre-tax operating income in the aggregate was increased by $129 million as a result of the update of assumptions, primarily due to net positive adjustments related to investment spread assumptions in the Fixed Annuities and Group Retirement businesses, partially offset by loss recognition for long-term care business in the Legacy Portfolio and additions to reserves for universal life with secondary guarantees in Life Insurance.
The adjustments related to the update of actuarial assumptions in each period are discussed by business module below.
In Group Retirement, the update of estimated gross profit assumptions resulted in a net negative adjustment of $47 million in 2016, primarily due to refinements in surrender and partial withdrawal assumptions and a decrease in the separate account long-term asset growth rate assumption from 8.5 percent to 7.5 percent (before expenses that reduce the asset base from which future fees are projected). In 2015, a net positive adjustment from the update of estimated gross profit assumptions of $48 million in Group Retirement was primarily due to revisions to mortality and surrender assumptions, partially offset by decreased spread assumptions. In 2014, a net positive adjustment of $46 million in Group Retirement was primarily due to more favorable assumptions for investment spreads and surrenders than previously assumed.
In Life Insurance, the update of actuarial assumptions resulted in a net negative adjustment of $92 million in 2016. This adjustment was primarily due to refinement to reserves for universal life insurance with secondary guarantees due to lower assumed surrender rates. The update to Life Insurance assumptions also included lower yield and interest credited assumptions.
The update of actuarial assumptions resulted in $622 million of loss recognition expense in 2016 on payout annuities in the Legacy Life Insurance Run-Off Lines. The loss recognition reflected the establishment of additional reserves primarily as a result of mortality experience studies, which indicated increased longevity, particularly on injured lives on a block of structured settlements underwritten prior to 2010. The mortality assumption update did not impact reserves for structured settlements and terminal funding annuities written after April 2012, which are in the Institutional Markets business.
Legacy Life Insurance Run-Off Lines recorded loss recognition expense of $28 million and $87 million to increase reserves for certain long-term care business in 2015 and 2014, respectively, which reduced pre-tax operating income in those periods. The loss recognition for both periods was primarily a result of lower future premium increase assumptions and, in 2014, lower yield assumptions.
Our Individual Retirement and Group Retirement businesses offer variable annuity products with GMWB riders that provide guaranteed living benefit features. The liabilities for GMWB are accounted for as embedded derivatives measured at fair value. The fair value of the embedded derivatives may fluctuate significantly based on market interest rates, equity prices, credit spreads and market volatility.
The variable annuity hedging program utilizes an economic hedge target, which represents an estimate of the underlying economic risks in our GMWB riders. The economic hedge target differs from the U.S. GAAP valuation of the GMWB embedded derivatives due to the following:
• The economic hedge target includes 100 percent of rider fees in present value calculations; the U.S. GAAP valuation reflects only those fees attributed to the embedded derivative such that the initial value at contract issue equals zero;
• The economic hedge target excludes the non-performance or “own credit” risk adjustment (NPA) used in the U.S. GAAP valuation, which reflects a market participant’s view of our claims-paying ability by incorporating an additional spread (the NPA spread) to the swap curve used to discount projected benefit cash flows. See Note 5 to the Consolidated Financial Statements for more information on our valuation methodology for embedded derivatives within policyholder contract deposits. Because the discount rate includes the NPA spread and other explicit risk margins, the U.S. GAAP valuation is generally less sensitive to movements in interest rates and other market factors, and to changes from actuarial assumption updates, than the economic hedge target.
• Basis risk due to the variance between expected and actual fund returns, which may be either positive or negative;
• Actual versus expected changes in the hedge target driven by assumptions not subject to hedging, particularly policyholder behavior; and
The impact on our pre-tax income (loss) of the variable annuity guaranteed living benefits and related hedging results include changes in the fair value of the GMWB embedded derivatives, and changes in the fair value of related derivative hedging instruments, both of which are recorded in Other realized capital gains (losses). Realized capital gains (losses), as well as net investment income from changes in the fair value of fixed maturity securities used in the hedging program, are excluded from pre-tax operating income of Individual Retirement and Group Retirement.
The change in the fair value of the embedded derivatives and the change in the value of the hedging portfolio are not expected to be fully offsetting, primarily due to the differences in valuation between the economic hedge target, the U.S. GAAP embedded derivatives, and changes in the fair value of the hedging portfolio, as discussed above. When corporate credit spreads widen, the change in the NPA spread generally reduces the fair value of the embedded derivative liabilities, resulting in a gain, and when corporate credit spreads narrow or tighten, the change in the NPA spread generally increases the fair value of the embedded derivative liabilities, resulting in a loss. In addition to changes driven by credit market-related movements in the NPA spread, the NPA balance also reflects changes in business activity and in the net amount at risk from the underlying guaranteed living benefits.
The increase in the economic hedge target in 2016 was primarily due to the update of actuarial assumptions offset by reductions from positive equity markets and increases in market interest rates, particularly in the fourth quarter of 2016. A decrease in market interest rates, lower equity market performance and the update of actuarial assumptions in 2015 resulted in increases in economic hedge target, which were significantly offset by changes in the value of the hedging portfolio. The increases in the economic hedge target in 2014 were primarily due to declines in interest rates and the update of actuarial assumptions, partially offset by higher equity market returns.
The changes in the fair value of the economic hedge target and, to a lesser extent, the embedded derivatives, were offset in part by the following changes in the fair value of the variable annuity hedging portfolio:
• Changes in the fair value of fixed maturity securities, for which the fair value option has been elected, are used as a capital-efficient way to economically hedge interest rate and credit spread-related risk. Effective June 30, 2015, we discontinued our U.S. Treasury bond interest rate hedging program and initiated a corporate bond hedging program, which is intended to provide the same capital efficiency as the previous U.S. Treasury bond hedging program. The change in the fair value of the corporate bond hedging program in 2016 included gains, primarily due to credit spreads tightening and decreases in market interest rates in the first nine months of 2016, partially offset by an increase in rates in the fourth quarter of 2016. The change in the fair value of the corporate bond hedging program in 2015 reflected losses, primarily due to increases in market interest rates in the first six months of 2015 and credit spreads widening. The gains in 2014 from the change in the fair value of the fixed maturities securities were due to decreases in market interest rates in 2014. The change in the fair value of the hedging bonds, which is excluded from the pre-tax operating income of the Individual Retirement and Group Retirement segments, is reported in net investment income on the Consolidated Statements of Income (Loss).
In 2016, tightening of credit spreads resulted in a negative impact on pre-tax income from the change in the NPA spread. In 2015, the impact of widening credit spreads resulted in a significant gain from the change in NPA spread, which was the primary driver of the net positive impact on pre-tax income, compared to a less significant gain from the change in NPA spread in 2014.
The following table summarizes the major components of the changes in DAC, including VOBA, within the life insurance companies, excluding DAC of Institutional Markets and Legacy Portfolio:
(a) DAC Other in 2014 represents VOBA related to the acquisition of AIG Life Limited.
(b) DAC balance excluding the amount related to unrealized depreciation (appreciation) of investments was $8.4 billion, $7.7 billion and $7.3 billion at December 31, 2016, 2015 and 2014, respectively.
Liquidity refers to the ability to generate sufficient cash resources to meet our payment obligations. It is defined as cash and unencumbered assets that can be monetized in a short period of time at a reasonable cost. We manage our liquidity prudently through various risk committees, policies and procedures, and a stress testing and liquidity risk framework established by Enterprise Risk Management (ERM). Our liquidity risk framework is designed to manage liquidity at both AIG Parent and subsidiaries to meet our financial obligations for a minimum of six-months under a liquidity stress scenario. See Enterprise Risk Management - Risk Appetite, Limits, Identification, and Measurement and Enterprise Risk Management - Liquidity Risk Management below for additional information.
Nevertheless, some circumstances may cause our cash or capital needs to exceed projected liquidity or readily deployable capital resources as was the case in 2008. Additional collateral calls, deterioration in investment portfolios or reserve strengthening affecting statutory surplus, higher surrenders of annuities and other policies, downgrades in credit ratings, or catastrophic losses may result in significant additional cash or capital needs and loss of sources of liquidity and capital. In addition, regulatory and other legal restrictions could limit our ability to transfer funds freely, either to or from our subsidiaries.
Depending on market conditions, regulatory and rating agency considerations and other factors, we may take various liability and capital management actions. Liability management actions may include, but are not limited to, repurchasing or redeeming outstanding debt, issuing new debt or engaging in debt exchange offers. Capital management actions may include, but are not limited to, paying dividends to our shareholders and share repurchases.
During 2016, AIG Parent received $7.5 billion in dividends and loan repayments from subsidiaries. Of this amount, $2.2 billion was dividends in the form of cash and fixed maturity securities from our Property Casualty Insurance Companies, $4.7 billion was dividends and loan repayments in the form of cash and fixed maturity securities from our Life Insurance Companies and $571 million was dividends in the form of cash and fixed maturity securities from UGC.
In February 2016, we issued $1.5 billion aggregate principal amount of 3.300% Notes due 2021.
In March 2016, we repurchased, through a cash tender offer, approximately $736 million aggregate principal amount of certain notes and debentures issued or guaranteed by AIG for an aggregate purchase price of approximately $825 million.
* For 2014, cash decreased by $162 million due to reclassification of $289 million to restricted cash presented in Other assets, partially offset by a $127 million reclassification from Short-term investments, to correct prior period presentation.
Net cash provided by investing activities in 2016 included approximately $2.8 billion of net cash proceeds from the sale of UGC, Ascot and AIG Advisor Group. Net cash provided by investing activities for 2015 included approximately $4.2 billion of net cash proceeds from the sale of ordinary shares of AerCap. Net cash provided by investing activities in 2014 included a reduction in net investment purchase activity and approximately $2.4 billion of net cash proceeds from the sale of ILFC.
• approximately $4.9 billion to repurchase approximately 88 million shares of AIG Common Stock;
As of December 31, 2016, AIG Parent had approximately $12.9 billion in liquidity sources. AIG Parent’s liquidity sources are primarily held in the form of cash, short-term investments and publicly traded, investment grade rated fixed maturity securities. Fixed maturity securities primarily include U.S. government and government sponsored entity securities, U.S. agency mortgage-backed securities, corporate and municipal bonds and certain other highly rated securities. AIG Parent actively manages its assets and liabilities in terms of products, counterparties and duration. Based upon an assessment of funding needs, the liquidity sources can be readily monetized through sales, repurchase agreements or contributed as admitted assets to regulated insurance companies. AIG Parent liquidity is monitored through the use of various internal liquidity risk measures. AIG Parent’s primary sources of liquidity are dividends, distributions, loans and other payments from subsidiaries and credit facilities. AIG Parent’s primary uses of liquidity are for debt service, capital and liability management, and operating expenses.
with businesses or investments that do not directly support our insurance operations may be available for distribution to shareholders or deployment towards liability management upon its monetization.
(c) For additional information relating to this syndicated credit facility, see Credit Facilities below.
Each of our material insurance companies’ liquidity is monitored through various internal liquidity risk measures. The primary sources of liquidity are premiums, fees, reinsurance recoverables and investment income. The primary uses of liquidity are paid losses, reinsurance payments, benefit claims, surrenders, withdrawals, interest payments, dividends, expenses, investments and collateral requirements.
Our Property Casualty Insurance Companies may require additional funding to meet capital or liquidity needs under certain circumstances. Large catastrophes may require us to provide additional support to our affected operations. Downgrades in our credit ratings could put pressure on the insurer financial strength ratings of our subsidiaries, which could result in non-renewals or cancellations by policyholders and adversely affect the subsidiary’s ability to meet its own obligations. Increases in market interest rates may adversely affect the financial strength ratings of our subsidiaries, as rating agency capital models may reduce the amount of available capital relative to required capital. Other potential events that could cause a liquidity strain include an economic collapse of a nation or region significant to our operations, nationalization, catastrophic terrorist acts, pandemics or other events causing economic or political upheaval.
AIG Parent and Ascot Corporate Name Limited (ACNL) were previously parties to a $725 million letter of credit facility. The letter of credit facility was released at the closing of AIG’s sale of its interest in Ascot Underwriting Holdings Ltd. and ACNL in November 2016.
Certain of our U.S. Life Insurance Companies have programs, which began in 2012, that lend securities from their investment portfolio to supplement liquidity or for other uses as deemed appropriate by management. Under these programs, these U.S. Life Insurance Companies lend securities to financial institutions and receive cash as collateral equal to 102 percent of the fair value of the loaned securities. Cash collateral received is invested in short-term investments. Additionally, the aggregate amount of securities that a Life Insurance Company is able to lend under its program at any time is limited to five percent of its general account statutory-basis admitted assets. At December 31, 2016 and 2015, our U.S. Life Insurance Companies had $2.4 billion and $1.1 billion, respectively, of securities subject to these agreements and $2.5 billion and $1.1 billion, respectively, of liabilities to borrowers for collateral received.
During 2016, we created a new Switzerland-domiciled international holding company, AIG International Holdings, GmbH (AIGIH), that is intended to be the ultimate holding company for all of our international entities. This new international holding company structure is part of our ongoing efforts to simplify our organizational structure, and is expected to facilitate the optimization of our international capital strategy from both a regulatory and tax perspective. Through February 14, 2017, the following international operations have been transferred to AIGIH: Europe, Canada, Asia Pacific (excluding Japan) and Latin America/Caribbean.
In 2016, our Property Casualty Insurance Companies paid approximately $2.2 billion in dividends in the form of cash and fixed maturity securities to AIG Parent. The fixed maturity securities primarily included U.S. government and government-sponsored entity securities, U.S. agency mortgage-backed securities, corporate and municipal bonds and certain other highly rated securities.
In 2016, our U.S. Life Insurance Companies paid approximately $4.7 billion of dividends and loan repayments in the form of cash and fixed maturity securities to AIG Parent, which included the release of approximately $1.0 billion of excess statutory capital resulting from a reinsurance agreement entered into by one of the Life Insurance Companies involving certain of its whole life and universal life businesses, effective July 1, 2016. The fixed maturity securities primarily included U.S. government and government sponsored entity securities, U.S. agency mortgage-backed securities, corporate and municipal bonds and certain other highly rated securities. The reinsurance agreement also resulted in a $49 million tax payment to AIG Parent. Effective December 31, 2016, the same life subsidiary recaptured certain term and universal life reserves previously ceded to an affiliate and ceded approximately $14 billion of such statutory reserves to an unaffiliated reinsurer under an amendment to the July 1, 2016 agreement, which is expected to result in a tax payment to AIG Parent of approximately $2.3 billion in 2017.
(b) Does not reflect unrecognized tax benefits of $4.5 billion, the timing of which is uncertain.
Loss reserves relate to our Property Casualty Insurance Companies and represent estimates of future loss and loss adjustment expense payments estimated based on historical loss development payment patterns. Due to the significance of the assumptions used, the payments by period presented above could be materially different from actual required payments. We believe that our Property Casualty Insurance Companies maintain adequate financial resources to meet the actual required payments under these obligations.
Insurance and investment contract liabilities, including GIC liabilities, relate to our Life Insurance Companies. These liabilities include various investment-type products with contractually scheduled maturities, including periodic payments. These liabilities also include benefit and claim liabilities, of which a significant portion represents policies and contracts that do not have stated contractual maturity dates and may not result in any future payment obligations. For these policies and contracts (i) we are not currently making payments until the occurrence of an insurable event, such as death or disability, (ii) payments are conditional on survivorship or (iii) payment may occur due to a surrender or other non-scheduled event beyond our control.
Our borrowings exclude those incurred by consolidated investments and include hybrid financial instrument liabilities recorded at fair value. We expect to repay the long-term debt maturities and interest accrued on borrowings by AIG through maturing investments and dispositions of invested assets, future cash flows from operations, cash flows generated from invested assets, future debt issuance and other financing arrangements. Borrowings supported by assets of AIG include various notes and bonds payable as well as GIAs that are supported by cash and investments held by AIG Parent and certain non-insurance subsidiaries for the repayment of those obligations.
(c) Does not include guarantees, CMAs or other support arrangements among AIG consolidated entities.
(f) Excludes commitments with respect to pension plans. The annual pension contribution for 2017 is expected to be approximately $70 million for U.S. and non-U.S. plans.
(a) AIG Parent guarantees all such debt, except for MIP notes payable and Series AIGFP matched notes and bonds payable, which are direct obligations of AIG Parent. Collateral posted to third parties was $2.2 billion and $2.4 billion at December 31, 2016 and 2015, respectively. This collateral primarily consists of securities of the U.S. government and government sponsored entities and generally cannot be repledged or resold by the counterparties.
For a discussion of the effects of downgrades in our credit ratings, see Note 11 to the Consolidated Financial Statements herein and Part I, Item 1A. Risk Factors - Liquidity, Capital and Credit.
For a discussion of the effects of downgrades in the financial strength ratings of our insurance companies, see Note 11 to the Consolidated Financial Statements herein and Part I, Item 1A. Risk Factors - Liquidity, Capital and Credit.
On February 14, 2017, our Board of Directors declared a cash dividend on AIG Common Stock of $0.32 per share, payable on March 29, 2017 to shareholders of record on March 15, 2017. The payment of any future dividends will be at the discretion of our Board of Directors and will depend on various factors, including the regulatory framework applicable to us, as discussed further in Note 17 to the Consolidated Financial Statements.
Our Board of Directors has authorized the repurchase of shares of AIG Common Stock through a series of actions. On November 2, 2016, our Board of Directors authorized an additional increase of $3.0 billion to the share repurchase authorization.
On February 14, 2017, our Board of Directors authorized an additional increase of $3.5 billion to the share repurchase authorization, resulting in a remaining authorization on such date of approximately $4.7 billion. Shares may be repurchased from time to time in the open market, private purchases, through forward, derivative, accelerated repurchase or automatic repurchase transactions or otherwise (including through the purchase of warrants). Certain of our share repurchases have been and may from time to time be effected through Exchange Act Rule 10b5-1 repurchase plans. The timing of any future share repurchases will depend on market conditions, our financial condition, results of operations, liquidity and other factors, including the regulatory framework applicable to us.
We have an integrated process for managing risks throughout our organization in accordance with our firm-wide risk appetite. Our Board of Directors has oversight responsibility for the management of risk. Our Enterprise Risk Management (ERM) Department supervises and integrates the risk management functions in each of our business units, providing senior management with a consolidated view of AIG’s major risk positions. Within each business unit, senior leaders and executives approve risk-taking policies and targeted risk tolerance within the framework provided by ERM. ERM supports our businesses and management in the embedding of risk management in our key day-to-day business processes and in identifying, assessing, quantifying, managing, monitoring and reporting, and mitigating the risks taken by us and our businesses. Nevertheless, our risk management efforts may not always be successful and material adverse effects on our business, results of operations, cash flows, liquidity or financial condition may occur.
We articulate our aggregate risk-taking by setting risk tolerances and thresholds on capital and liquidity measures. These measures are set at the AIG Parent level as well as the legal entity level and cover consolidated and insurance company capital and liquidity ratios. We must comply with standards for capital adequacy and maintain sufficient liquidity to meet all our obligations as they come due in accordance with our internal capital management and liquidity policies. Our risk tolerances take into consideration regulatory requirements, rating agency expectations, and business needs. The GRC routinely reviews the level of risk taken by the consolidated
• Defining a consistent and transparent approach to limits governance; and
• Board level risk tolerances are AIG’s aggregate capital and liquidity limits. They define the minimum level of capital and liquidity that we should maintain. These board level risk tolerances require our RCC approval.
• BU level limits are set to address key risks identified by ERM for the business unit/module and/or meet business unit/module specific requirements by regulators and rating agencies. These limits are defined by the business unit risk officers.
• developing methodologies for quantification and assessment of credit risks, including the establishment and maintenance of our internal risk rating process;
Residential and commercial real estate values. Our investment portfolios are exposed to the risk of changing values in a variety of residential and commercial real estate investments. Changes in residential/commercial real estate prices can affect the valuation of residential/commercial mortgages, residential/commercial mortgage-backed securities and other structured securities with underlying assets that include residential/commercial mortgages, trusts that include residential/commercial real estate and/or mortgages, residential mortgage insurance contracts and commercial real estate investments.
Commodity Prices. Changes in commodity prices (the value of commodities) can affect the valuation of publicly-traded commodities, commodity indices and derivatives on commodities and commodity indices. We are exposed to commodity prices primarily through their impact on the prices and credit quality of commodity producers’ debt and equity securities in our investment portfolio.
Inflation. Changes in inflation can affect the valuation of fixed maturity securities, including AIG-issued debt obligations, derivatives and other contracts explicitly linked to inflation indices, and insurance contracts where the claims are linked to inflation either explicitly, via indexing, or implicitly, through medical costs or wage levels.
Scenario analysis. Scenario analysis uses historical, hypothetical, or forward-looking macroeconomic scenarios to assess and report exposures. Examples of hypothetical scenarios include a 100 basis point parallel shift in the yield curve or a 20 percent immediate and simultaneous decrease in world-wide equity markets. Scenarios may also utilize a stochastic framework to arrive at a probability distribution of losses.
(a) At December 31, 2016, the analysis covered $276.9 billion of $292.5 billion interest-rate sensitive assets. Excluded were $8.1 billion of loans and $2.5 billion of investments in life settlements. In addition, $5.0 billion of assets across various asset categories were excluded due to modeling limitations. At December 31, 2015, the analysis covered $279.6 billion of $298.7 billion interest-rate sensitive assets. Excluded were $10.7 billion of loans and $3.6 billion of investments in life settlements. In addition, $4.8 billion of assets across various asset categories were excluded due to modeling limitations.
Foreign currency-denominated net asset position reflects our consolidated non-U.S. dollar assets less our consolidated non-U.S dollar liabilities on a GAAP basis, with certain adjustments. We use a bottom-up approach in managing our foreign currency exchange rate exposures with the objective of protecting statutory capital at the regulated insurance entity level. At the AIG Parent level, we monitor our single foreign currency exposures and limit the risk of the aggregate currency portfolio.
Our foreign currency-denominated net asset position at December 31, 2016, decreased by $830 million compared to December 31, 2015. The decrease was mostly due to a $1.6 billion decrease in our Hong Kong dollar position, primarily resulting from the sale of our Property Casualty Insurance Companies’ PICC Investment, partially offset by a $600 million increase in our Japanese yen position primarily due to hedging activities, unrealized appreciation, and strengthening of the yen against the U.S. dollar.
The sensitivity factors utilized for 2016 and presented above were selected based on historical data from 1996 to 2016, as follows (see the table below):
AIG Parent liquidity risk tolerance levels are designed to allow it to meet our financial obligations for a minimum of six- months under a liquidity stress scenario. We maintain liquidity limits and minimum coverage ratios designed to ensure that funding needs are met under varying market conditions. If we project that we will breach these tolerances, we will assess and determine appropriate liquidity management actions. However, the market conditions in effect at that time may not permit us to achieve an increase in liquidity sources or a reduction in liquidity requirements.
• Event Funding Risk: Additional funding may be required as the result of a trigger event. Event funding risk comes in many forms and may result from a downgrade in credit ratings, a market event, or some other event that creates a funding obligation or limits existing funding options.
Coverage Ratios: Coverage Ratios measure the adequacy of available liquidity sources, including the ability to monetize assets to meet the forecasted cash flows over a specified time horizon. The portfolio of assets is selected based on our ability to convert those assets into cash under the assumed market conditions and within the specified time horizon.
Stress Testing: Asset liquidity and Coverage Ratios are re-measured under defined liquidity stress scenarios that will impact net cash flows, liquid assets and/or other funding sources.
Operational risk is defined as the risk of loss, or other adverse consequences, resulting from inadequate or failed internal processes, people, systems, or from external events. Operational risk includes legal, regulatory and compliance risks, and excludes business and strategy risks.
ORM, working together with other second lines of defense functions (e.g., Model Validation and the Technology Risk office, as well as Compliance, Sarbanes Oxley, and Global Business Continuity), provides an independent view of Operational Risk for each business, and works with the business to facilitate implementation of the above programs. This includes coverage of operational risks related to core insurance activities, investing, model risk, technology (including cyber security, access, data privacy and data security), third-party providers, as well as compliance and regulatory matters. Based on the results of the risk identification and assessment efforts above, business leaders are accountable for tracking and remediating identified issues in line with our risk monitoring procedures. Governance committees support these efforts and promote transparency and management decision making.
• pro-actively address potential risk issues and assign clear ownership and accountability for addressing identified risk issues; and
• accelerate the development of technology solutions that support the objectives above.
• Life Insurance Companies - risks include mortality and morbidity in the insurance-oriented products and insufficient cash flows to cover contract liabilities and longevity risk in the retirement savings-oriented products. We manage risks through product design, sound medical and non-medical underwriting, and external reinsurance programs.
• Loss Reserves - The potential inadequacy of the liabilities we establish for unpaid losses and loss adjustment expenses is a key risk faced by the Property Casualty Insurance Companies. There is significant uncertainty in factors that may drive the ultimate development of losses compared to our estimates of losses and loss adjustment expenses. We manage this uncertainty through internal controls and oversight of the loss reserve setting process, as well as reviews by external experts. See Item 7. MD&A - Critical Accounting Estimates - Insurance Liabilities - Loss Reserves herein for further information.
The OEP estimates provided above reflect our in-force portfolios at September 30, 2016, for both U.S. and Japan exposures. The catastrophe reinsurance program is as of January 1, 2017.
AIG, along with other property casualty insurance and reinsurance companies, uses industry-recognized catastrophe models and applies proprietary modeling processes and assumptions to arrive at loss estimates. The use of different methodologies and assumptions could materially change the projected losses. Since there is no industry standard for assumptions and preparation of insured data for use in these models, our modeled losses may not be comparable to estimates made by other companies.
Our 2017 catastrophe reinsurance program includes coverage for natural catastrophes and some coverage for terrorism events. It consists of a large North American occurrence cover (without reinstatement) to protect against large North America losses, and Japan covers to protect against losses in Japan. The attachment point for this reinsurance program is at $1.5 billion for the North American cover ($3 billion in 2016) and varies for the Japan covers. The North American cover has reduced the U.S. Hurricane (1-in-100) OEP net of reinsurance from $3.1 billion under the 2016 reinsurance program to $2.0 billion under the 2017 program.
We actively monitor terrorism risk and manage exposures to losses from terrorist attacks. We have set risk limits based on modeled losses from certain terrorism attack scenarios. Terrorism risks are modeled using a third-party vendor model and various terrorism attack modes and scenarios. Adjustments are made to account for vendor model gaps and the nature of the Property Casualty Insurance Companies exposures. Examples of modeled scenarios are conventional bombs of different sizes, anthrax attacks and nuclear attacks.
Our exposure to terrorism risk in the U.S. is mitigated by TRIPRA in addition to limited private reinsurance protections. TRIPRA covers terrorist attacks within the United States or U.S. missions and against certain U.S. carriers or vessels and excludes certain lines of business as specified by applicable law. In 2017, TRIPRA covers 83 percent of insured losses above a deductible, decreasing by one percent each year to 80 percent in 2020. The current estimate of our deductible is approximately $2.5 billion for 2016.
We offer terrorism coverage in many other countries through various insurance products and participate in country terrorism pools when applicable. International terrorism exposure is estimated using scenario-based modeling and exposure concentration is monitored routinely. Targeted reinsurance purchases are made for some lines of business to cover potential losses due to terrorist attacks. We also rely on the government sponsored and government arranged terrorism reinsurance programs, including pools, in force in applicable non-U.S. jurisdictions.
Reinsurance is used primarily to manage overall capital adequacy and mitigate the insurance loss exposure related to certain events such as natural and man-made catastrophes. Our subsidiaries operate worldwide primarily by underwriting and accepting risks for their direct account on a gross basis and reinsuring a portion of the exposure on either an individual risk or an aggregate basis to the extent those risks exceed the desired retention level. In addition, as a condition of certain direct underwriting transactions, we may be required by clients, agents or regulation to cede all or a portion of risks to specified reinsurance entities, such as captives, other insurers, local reinsurers and compulsory pools.
• Other insurers that engage in both direct and assumed reinsurance.
At December 31, 2016, total reinsurance recoverable assets were $21.9 billion. These assets include general reinsurance paid losses recoverable of $1.1 billion, ceded loss reserves of $15.7 billion including reserves for IBNR, and ceded reserves for unearned premiums of $3.4 billion, as well as life reinsurance recoverables of $1.7 billion. The methods used to estimate IBNR and to establish the resulting ultimate losses involve projecting the frequency and severity of losses over multiple years. These methods are continually reviewed and updated by management. Any adjustments are reflected in income. We believe that the amount recorded for ceded loss reserves at December 31, 2016 reflects a reasonable estimate of the ultimate losses recoverable. Actual losses may, however, differ, perhaps materially, from the reserves currently ceded.
(b) Total reinsurance assets include both the Property Casualty Insurance Companies and the Life Insurance Companies reinsurance recoverable.
(d) Includes $1.8 billion recoverable under the 2011 retroactive reinsurance transaction pursuant to which a large portion of the Property Casualty Insurance Companies net domestic asbestos liabilities were transferred to NICO. Does not include reinsurance assets ceded to other reinsurers for which NICO has assumed the collection risk. We entered into an adverse development reinsurance agreement with NICO, discussed in Item 7. MD&A - Insurance Reserves - Reinsurance Activities. Based on reserves as of December 31, 2016, this agreement will increase the gross reinsurance assets and collateral held from the Berkshire Hathaway Group of Companies by approximately $12.8 billion and $10.2 billion, respectively.
At December 31, 2016, we had no significant general reinsurance recoverable due from any individual reinsurer that was financially troubled. Reinsurer capital levels remained stable in 2016, and the industry’s robust underwriting capacity resulted in continued competition and attractive rates for 2017 renewals. Reduced profitability associated with lower rates could potentially result in reduced capacity or rating downgrades for some reinsurers. The RCD, in conjunction with the credit executives within ERM, reviews these developments, monitors credit triggers that may require the reinsurer to post collateral, and seeks to use other appropriate means to mitigate any material risks arising from these developments.
• Interest rate risk - represents the potential for loss due to a change in interest rates. Interest rate risk is measured with respect to assets, liabilities (both insurance-related and financial) and derivatives. This risk manifests itself when interest rates move significantly in a short period of time. Rapidly rising interest rates create the potential for increased surrenders. Interest rate risk
can also manifest itself over a longer period of time, such as in a persistent low interest rate environment. Low long-term interest rates put pressure on investment returns, which may negatively affect sales of interest rate sensitive products and reduce, or eliminate future profits on certain existing fixed rate products.
• Equity risk - represents the potential for loss due to changes in equity prices. It affects equity-linked insurance products, including but not limited to index annuities, variable annuities (and associated guaranteed living and death benefits, as discussed below), universal life insurance and variable universal life insurance. In addition, changes in the volatility of equity prices can affect the valuation of insurance features that are accounted for as embedded derivatives and the related economic hedges.
Our Individual and Group Retirement businesses offer variable annuity products with GMWB riders that guarantee a certain level of benefits. GMWB guaranteed living benefits are accounted for as embedded derivatives measured at fair value, with changes in the fair value recorded in Other realized capital gains (losses). GMWB features subject the Life Insurance Companies to market risk, including exposure to changes in interest rates, equity prices, credit spreads and market volatility.
Variable annuity product design is the first step in managing our exposure to these market risks. Risk mitigation features of our variable annuity product design include GMWB rider fees indexed to an equity market volatility index, which can provide additional fee assessments in periods of increased market volatility, required minimum allocations to fixed accounts to reduce overall equity exposure, and the utilization of volatility control funds, which reduce equity exposure in the funds in response to changes in market volatility, even under sudden or extreme market movements.
Our hedging program utilizes an economic hedge target, which represents our estimate of the underlying economic risks in our GMWB riders, based on the present value of the future expected benefit payments for the GMWB, less the present value of future rider fees, over numerous stochastic scenarios. This stochastic projection method uses best estimate assumptions for policyholder behavior (including mortality, lapses, withdrawals and benefit utilization) in conjunction with market scenarios calibrated to observable equity and interest rate option prices. Policyholder behaviors are regularly evaluated to compare current assumptions to actual experience and, if appropriate, changes are made to the policyholder behavior assumptions. The risk of changes in policyholder behavior is not explicitly hedged and such differences between expected and actual policyholder behaviors may result in hedge ineffectiveness.
Due to differences between the calculation of the economic hedge target and U.S. GAAP valuation of the embedded derivative, which include differences in the treatment of rider fees and exclusion of certain risk margins and other differences in discount rates, we expect relative movements in the economic hedge target and the U.S. GAAP embedded derivative valuation will vary over time with changes in equity markets, interest rates and credit spreads. See Insurance Reserves - Life and Annuity Reserves and DAC - Variable Annuity Guaranteed Benefits and Hedging Results for information on the impact on our consolidated pre-tax income from the change in fair value of the embedded derivatives and the hedging portfolio, as well as additional discussion of differences between the economic hedge target and the valuation of the embedded derivatives.
To manage the capital market exposures embedded within the economic hedge target, we identify and hedge market sensitivities to changes in equity markets, interest rates, volatility and for variable annuities, credit spreads. Each hedge program purchases derivative instruments or securities having sensitivities that offset those in the economic hedge target, within internally defined threshold levels. Since the relative movements of the hedging portfolio and the economic hedge target vary over time or with market changes, the net exposure can be outside the threshold limits, and adjustments to the hedging portfolio are made periodically to return the net exposure to within threshold limits.
The fair value of our interest rate, currency, credit, commodity and equity swaps, options, swaptions, and forward commitments, futures, and forward contracts reported as a component of Other Assets, was approximately $1.8 billion at December 31, 2016 and $1.3 billion at December 31, 2015. Where applicable, these amounts have been determined in accordance with the respective master netting agreements.
Book Value Per Common Share Excluding Accumulated Other Comprehensive Income (AOCI), Book Value Per Common Share Excluding AOCI and Deferred Tax Assets (DTA) (Adjusted Book Value Per Common Share) and Adjusted Book Value Per Common Share Including Dividend Growth are non-GAAP measures and are used to show the amount of our net worth on a per-share basis. Book Value Per Common Share Excluding AOCI is derived by dividing total AIG shareholders’ equity, excluding AOCI, by total common shares outstanding. Adjusted Book Value Per Common Share is derived by dividing total AIG shareholders’ equity, excluding AOCI and DTA (Adjusted Shareholders’ Equity), by total common shares outstanding. Adjusted Book Value Per Common Share including Dividend Growth is derived by dividing Adjusted Shareholders’ Equity, including growth in quarterly dividends above $0.125 per share to shareholders, by total common shares outstanding.
Master netting agreement An agreement between two counterparties who have multiple derivative contracts with each other that provides for the net settlement of all contracts covered by such agreement, as well as pledged collateral, through a single payment, in a single currency, in the event of default on or upon termination of any one such contract.
Natural catastrophe losses are generally weather or seismic events having a net impact on AIG in excess of $10 million each. Catastrophes also include certain man-made events, such as terrorism and civil disorders that meet the $10 million threshold.
Premiums and deposits - Institutional Markets include direct and assumed amounts received and earned on group benefit policies and life-contingent payout annuities, and deposits received on investment-type annuity contracts, including GICs.
Premiums and deposits - Individual Retirement and Group Retirement and - Life Insurance include direct and assumed amounts received on traditional life insurance policies and group benefit policies, and deposits on life-contingent payout annuities, as well as deposits received on universal life, investment-type annuity contracts and mutual funds.
Property Casualty Insurance Companies include the following major operating companies: National Union Fire Insurance Company of Pittsburgh, Pa. (National Union); American Home Assurance Company (American Home); Lexington Insurance Company (Lexington); Fuji Fire and Marine Insurance Company Limited (Fuji Fire); American Home Assurance Company, Ltd. (American Home Japan); AIU Insurance Company, Ltd. (AIUI Japan); AIG Asia Pacific Insurance, Pte, Ltd.; and AIG Europe Limited.
Severe losses Individual non-catastrophe first party losses and surety losses greater than $10 million, net of related reinsurance and salvage and subrogation. Severe losses include claims related to satellite explosions, plane crashes, and shipwrecks.
Surrender rate represents annualized surrenders and withdrawals as a percentage of average reserves and Group Retirement mutual fund assets under administration.
Supplementary Insurance Information at December 31, 2016, 2015 and 2014 and for the years then ended
Other common and preferred stock, at fair value (See Note 6)
(portion measured at fair value: 2016 - $1,809; 2015 - $1,309)
Other liabilities (portion measured at fair value: 2016 - $2,016; 2015 - $2,082)
Long-term debt (portion measured at fair value: 2016 - $3,428; 2015 - $3,670)
Certain of our foreign subsidiaries included in the Consolidated Financial Statements report on different fiscal-period bases. The effect on our consolidated financial condition and results of operations of all material events occurring at these subsidiaries through the date of each of the periods presented in these Consolidated Financial Statements has been considered for adjustment and/or disclosure.
On December 31, 2016, we sold our 100 percent interest in United Guaranty Corporation (UGC) and certain related affiliates to Arch Capital Group Ltd. (Arch) for total consideration of $3.3 billion, consisting of $2.2 billion of cash and approximately $1.1 billion of newly issued Arch convertible non-voting common-equivalent preferred stock and reported a pre-tax gain of approximately $697 million. We also received $261 million in pre-closing dividends from UGC in the fourth quarter of 2016.
On May 14, 2014, we completed the sale of 100 percent of the common stock of International Lease Finance Corporation (ILFC) to AerCap Ireland Limited, a wholly owned subsidiary of AerCap Holdings N.V. (AerCap), in exchange for total consideration of approximately $7.6 billion, including cash and 97.6 million newly issued AerCap common shares (the AerCap Transaction). The total value of the consideration was based in part on AerCap’s closing price per share of $47.01 on May 13, 2014. ILFC’s results of operations are reflected in Aircraft leasing revenue and Aircraft leasing expenses in the Consolidated Statements of Income (Loss) through the date of the completion of the sale.
The cost of buildings and furniture and equipment is depreciated principally on the straight-line basis over their estimated useful lives (maximum of 40 years for buildings and 10 years for furniture and equipment). Expenditures for maintenance and repairs are charged to income as incurred and expenditures for improvements are capitalized and depreciated. We periodically assess the carrying amount of our real estate for purposes of determining any asset impairment. Capitalized software costs, which represent costs directly related to obtaining, developing or upgrading internal use software, are capitalized and amortized using the straight-line method over a period generally not exceeding five years. Real estate, fixed assets and other long-lived assets are assessed for impairment when impairment indicators exist.
Other liabilities consist of other funds on deposit, other payables, securities sold under agreements to repurchase, securities sold but not yet purchased and derivative liabilities. We have entered into certain insurance and reinsurance contracts, primarily in our Property Casualty Insurance Companies, that do not contain sufficient insurance risk to be accounted for as insurance or reinsurance. Accordingly, the premiums received on such contracts, after deduction for certain related expenses, are recorded as deposits within Other liabilities in the Consolidated Balance Sheets. Net proceeds of these deposits are invested and generate Net investment income. As amounts are paid, consistent with the underlying contracts, the deposit liability is reduced. Also included in Other liabilities are trade payables for the DIB and GCM, which include option premiums received and payables to counterparties that relate to unrealized gains and losses on futures, forwards, and options and balances due to clearing brokers and exchanges. Trade payables for GCM also include cash collateral received from derivative counterparties that contractually cannot be netted against derivative assets.
Non-redeemable noncontrolling interest is the portion of equity (net assets) in a subsidiary not attributable, directly or indirectly, to a parent.
Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity
We adopted the standard prospectively on its required effective date of January 1, 2016. The adoption of this standard did not have a material effect on our consolidated financial condition, results of operations or cash flows.
In April 2015, the FASB issued an accounting standard that provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The guidance does not change generally accepted accounting principles applicable to a customer's accounting for service contracts. Consequently, all software licenses will be accounted for consistent with other licenses of intangible assets.
In April 2015, the FASB issued an accounting standard that amends the guidance for debt issuance costs by requiring such costs to be presented as a deduction to the corresponding debt liability, rather than as an asset, and for the amortization of such costs to be reported as interest expense. The amendments are intended to simplify the presentation of debt issuance costs and make it consistent with the presentation of debt discounts or premiums. The amendments, however, do not change the recognition and measurement guidance applicable to debt issuance costs.
We adopted the standard retrospectively on its required effective date of January 1, 2016. Because the new standard did not affect accounting recognition or measurement of debt issuance costs, the adoption of the standard did not have a material effect on our consolidated financial condition, results of operations or cash flows.
We adopted this standard on its required effective date of December 31, 2016. The required disclosures, reflected in Note 13, did not have any effect on our consolidated financial condition, results of operations or cash flows. In addition, the roll forward of the liability for unpaid losses and loss adjustment expenses currently disclosed in the annual financial statements will be disclosed as required for interim periods beginning in the first quarter of 2017.
The standard is effective on January 1, 2018 and may be applied retrospectively or through a cumulative effect adjustment to retained earnings at the date of adoption. Early adoption is permitted as of January 1, 2017, including interim periods. We are currently evaluating the impact to our revenue sources that are in scope of the standard. However, as the majority of our revenue sources are not in scope of the standard, we do not expect the adoption of the standard to have a material effect on our reported consolidated financial condition, results of operations or cash flows.
carrying value of the equity investments recorded in earnings. The standard also updates certain fair value disclosure requirements for financial instruments carried at amortized cost.
The standard is effective on January 1, 2018, with early adoption of certain provisions permitted. We are assessing the impact of the standard on our reported consolidated financial condition, results of operations and cash flows.
We will adopt the standard on its January 1, 2017 effective date, and do not expect the adoption of the standard will have a material effect on our reported consolidated financial condition, results of operations or cash flows.
In June 2016, the FASB issued an accounting standard that will change how entities account for credit losses for most financial assets. The standard will replace the existing incurred loss impairment model with a new “current expected credit loss model” and will apply to financial assets subject to credit losses, those measured at amortized cost and certain off-balance sheet credit exposures. The impairment for available-for-sale debt securities will be measured in a similar manner, except that losses will be recognized as allowances rather than reductions in the amortized cost of the securities. The standard will also require additional information to be disclosed in the footnotes.
In August 2016, the FASB issued an accounting standard that addresses diversity in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments provide clarity on the treatment of eight specifically defined types of cash inflows and outflows. The standard is effective on January 1, 2018, with early adoption permitted as long as all amendments are included in the same period.
In October 2016, the FASB issued an accounting standard that amends the consolidation analysis for a reporting entity that is the single decision maker of a VIE. The new guidance will require the decision maker’s evaluation of its interests held through related parties that are under common control on a proportionate basis (rather than in their entirety) when determining whether it is the primary beneficiary of that VIE. The amendment does not change the characteristics of a primary beneficiary.
· Consumer Insurance business included our Retirement, Life and Personal Insurance operating segments
· Group Retirement - consists of group mutual funds, group fixed annuities, group variable annuities, individual annuity and investment products, financial planning and advisory services.
· Personal Insurance - consists of personal auto and property insurance, voluntary and sponsor-paid personal accident and supplemental health products for individuals, employees, associations and other organizations, a broad range of travel insurance products and services for leisure and business travelers as well as extended warranty insurance covering electronics, appliances, and HVAC industries.
· Fuji Life - consists of term insurance, life insurance, endowment policies and annuities. On November 14, 2016, we entered into an agreement to sell our Japan life insurance business, AIG Fuji Life Insurance Company, Ltd. (AFLI), to FWD Group, the insurance arm of Pacific Century Group.
· Legacy Property and Casualty Run-Off Insurance Lines - include excess workers’ compensation, asbestos and environmental exposures.
· Legacy Life Insurance Run-Off Lines - include whole life, long term care and exited Accident & Health product lines. Also includes certain structured settlement, terminal funding and single premium immediate annuities written prior to April 2012.
· Legacy Investments - include investment classes that AIG has placed into run-off (life settlements, Legacy Global Real Estate, the Direct Investment book) and equity-like securities with high yield/ high-risk characteristics.
On December 31, 2016, we completed the sale of UGC to Arch. See Note 1 for a further discussion.
Investment income of the Property Casualty Insurance Companies is attributed to the Liability and Financial Lines, Property and Special Risks and Personal Insurance operating segments based on an internal investment income allocation model. The model estimates investable funds based primarily on loss reserves and unearned premiums. Investment income of the Life Insurance Companies is attributed to the Individual Retirement, Group Retirement and Life Insurance operating segments as well as the Institutional Markets business and the Legacy Life Insurance Run-Off Lines based on invested assets in segregated product line portfolios; income from invested assets in excess of liabilities is allocated to product lines based on internal capital estimates.
Certain of our management activities, such as investment management, enterprise risk management, liquidity management and capital management are conducted on a legal entity basis. We group our insurance-related legal entities into two categories: Property Casualty Insurance Companies, and Life Insurance Companies.
On October 18, 2016, we entered into agreements to sell certain insurance operations to Fairfax Financial Holdings Limited (Fairfax). The agreements include the sale of our subsidiary operations in Argentina, Chile, Colombia, Uruguay and Venezuela, as well as insurance operations in Turkey. Fairfax will also acquire renewal rights for the portfolios of local business written by our operations in Bulgaria, Czech Republic, Hungary, Poland, Romania and Slovakia, and assume certain of our operating assets and employees. Total cash consideration to us is expected to be approximately $240 million. The transactions are subject to obtaining the relevant regulatory approvals and other customary closing conditions.
The fair value of embedded derivatives contained in certain variable annuity and equity-indexed annuity and life contracts is measured based on actuarial and capital market assumptions related to projected cash flows over the expected lives of the contracts. These discounted cash flow projections primarily include benefits and related fees assessed, when applicable. In some instances, the projected cash flows from fees may exceed projected cash flows related to benefit payments and therefore, at a point in time, the carrying value of the embedded derivative may be in a net asset position. The projected cash flows incorporate best estimate assumptions for policyholder behavior (including mortality, lapses, withdrawals and benefit utilization), along with an explicit risk margin to reflect a market participant’s estimates of projected cash flows and policyholder behavior. Estimates of future policyholder behavior are subjective and based primarily on our historical experience.
Projected cash flows are discounted using the interest rate swap curve (swap curve), which is commonly viewed as being consistent with the credit spreads for highly-rated financial institutions (S&P AA-rated or above). A swap curve shows the fixed-rate leg of a non-complex swap against the floating rate (for example, LIBOR) leg of a related tenor. We also incorporate our own risk of non-performance in the valuation of the embedded derivatives associated with variable annuity and equity-indexed annuity and life contracts. The non-performance risk adjustment reflects a market participant’s view of our claims-paying ability by incorporating an additional spread to the swap curve used to discount projected benefit cash flows in the valuation of these embedded derivatives. The non-performance risk adjustment is calculated by constructing forward rates based on a weighted average of observable corporate credit indices to approximate the claims-paying ability rating of our Life Insurance Companies.
During the years ended December 31, 2016 and 2015, transfers out of Level 3 assets primarily included private placement and other corporate debt, CMBS, CDO/ABS, RMBS and certain investments in municipal securities. Transfers of certain investments in municipal securities, corporate debt, RMBS, CMBS and CDO/ABS out of Level 3 assets were based on consideration of market liquidity as well as related transparency of pricing and associated observable inputs for these investments. Transfers of certain investments in private placement corporate debt and certain ABS out of Level 3 assets were primarily the result of using observable pricing information that reflects the fair value of those securities without the need for adjustment based on our own assumptions regarding the characteristics of a specific security or the current liquidity in the market.
There were no significant transfers of derivative or other liabilities into or out of Level 3 for the years ended December 31, 2016 and 2015.
(d) Mortality inputs are shown as multipliers of the 2012 Individual Annuity Mortality Basic table for GMWB, and the 1975-1980 Modified Basic Table for index annuities.
• Equity / interest rate correlation estimates the relationship between changes in equity returns and interest rates, based on current market conditions and expected views of market participants, in the economic scenario generator used to value our GMWB embedded derivatives. In general, a higher positive correlation assumes that equity markets and interest rates move in a more correlated fashion, which generally increases the fair value of the liability.
Fair Value Using Net Asset Value Per Share (or its equivalent)
* Certain hedge funds for the year ended December 31, 2016 were reclassified into different strategies to better align with the investments in those funds.
Interest income and dividend income on assets measured under the fair value option are recognized and included in Net investment income in the Consolidated Statements of Income with the exception of activity within AIG’s Other Operations category, which is included in Other income. Interest expense on liabilities measured under the fair value option is reported in Other Income in the Consolidated Statements of Income. See Note 6 herein for additional information about our policies for recognition, measurement, and disclosure of interest and dividend income.
There were no mortgage or other loans receivable for which the fair value option was elected that were 90 days or more past due or in non-accrual status at December 31, 2016 or 2015.
Fixed maturity and equity securities classified as available for sale are carried at fair value. Unrealized gains and losses from available for sale investments in fixed maturity and equity securities are reported as a separate component of Accumulated other comprehensive income, net of deferred policy acquisition costs and deferred income taxes, in shareholders’ equity. Realized and unrealized gains and losses from fixed maturity and equity securities measured at fair value at our election are reflected in Net investment income (for insurance subsidiaries) or Other income (for Other Operations). Investments in fixed maturity and equity securities are recorded on a trade-date basis.
For the years ended December 31, 2016, 2015 and 2014, the aggregate fair value of available for sale securities sold was $30.2 billion, $28.7 billion and $25.3 billion, which resulted in net realized capital gains of $1.1 billion, $1.1 billion and $0.7 billion, respectively.
(a) At December 31, 2016, includes hedge funds of $7.2 billion, private equity funds of $5.5 billion, and affordable housing partnerships of $625 million. At December 31, 2015, includes hedge funds of $10.9 billion, private equity funds of $6.5 billion, and affordable housing partnerships of $701 million.
At December 31, 2016, 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, 2017 and the four succeeding years ending December 31, 2021 are $390 million, $402 million, $414 million, $422 million and $429 million, respectively.
• Reductions to the amortized cost basis of available for sale fixed maturity securities, available for sale equity securities and certain other invested assets for other-than-temporary impairments.
Our equity and cost method investments in private equity funds, hedge funds and other entities are evaluated for impairment similar to the evaluation of equity securities for impairments as discussed above. Such evaluation considers market conditions, events and volatility that may impact the recoverability of the underlying investments within these private equity funds and hedge funds and is based on the nature of the underlying investments and specific inherent risks. Such risks may evolve based on the nature of the underlying investments.
ITEM 8 | Notes to Consolidated Financial Statements | 6. Investments
In general, fair value estimates for the investments in life settlements are calculated using cash flows based on medical underwriting ratings of the policies from a third-party underwriter, applied to an industry mortality table. Our mortality assumptions are based on an industry table as supplemented with proprietary data on the older age mortality of U.S. insured lives. Mortality improvement factors are applied to these assumptions based on our view of future mortality improvements likely to apply to the U.S. insured lives population. Our mortality assumptions coupled with the mortality improvement rates are used in our estimate of future net cash flows from the investments in life settlements.
Certain of our subsidiaries are members of Federal Home Loan Banks (FHLBs) and such membership requires the members to own stock in these FHLBs. We owned an aggregate of $114 million and $47 million of stock in FHLBs at December 31, 2016 and 2015, respectively. In addition, our subsidiaries have pledged securities available for sale and residential loans associated with advances from FHLB, with a fair value of $3.4 billion and $17 million, respectively, at December 31, 2016 and securities available for sale at December 31, 2015 with a fair value of $1.2 billion.
* Commercial mortgages primarily represent loans for offices, apartments and retail, with exposures in New York and California representing the largest geographic concentrations (aggregating approximately 24 percent and 12 percent, respectively, at December 31, 2016, and 22 percent and 12 percent, respectively, at December 31, 2015).
(c) 100 percent of the commercial mortgages held at such respective dates were current as to payments of principal and interest. There were no significant amounts of nonperforming commercial mortgages (defined as those loans where payment of contractual principal or interest is more than 90 days past due) during any of the periods presented.
Interest income is not accrued when payment of contractual principal and interest is not expected. Any cash received on impaired loans is generally recorded as a reduction of the current carrying amount of the loan. Accrual of interest income is generally resumed when delinquent contractual principal and interest is repaid or when a portion of the delinquent contractual payments are made and the ongoing required contractual payments have been made for an appropriate period.
* Of the total allowance at the end of the year, $11 million, $24 million and $55 million relates to individually assessed credit losses on $280 million, $507 million and $192 million of commercial mortgages as of December 31, 2016, 2015 and 2014, respectively.
Loans that had been modified in troubled debt restructurings during the twelve-month period ended December 31, 2016 have been fully paid off. For the twelve-month period ended December 31, 2015, loans with a carrying value of $36 million, were modified in troubled debt restructurings.
ITEM 8 | Notes to Consolidated Financial Statements | 8. Reinsurance
Long-duration reinsurance recoveries, which reduced Policyholder benefits and losses incurred, were approximately $1.0 billion for both of the years ended December 31, 2016 and 2015, and $731 million for the year ended December 31, 2014.
Long-duration insurance in-force assumed represented 0.03 percent of gross long-duration insurance in-force at December 31, 2016, and 0.04 percent at both December 31, 2015 and 2014; and premiums assumed represented 3 percent, 0.1 percent and 0.5 percent of gross premiums for the years ended December 31, 2016, 2015 and 2014, respectively.
Our third-party reinsurance arrangements do not relieve us from our direct obligations to our beneficiaries. Thus, a credit exposure exists with respect to both short-duration and long-duration reinsurance ceded to the extent that any reinsurer fails to meet the obligations assumed under any reinsurance agreement. We hold substantial collateral as security under related reinsurance agreements in the form of funds, securities, and/or letters of credit. A provision has been recorded for estimated unrecoverable reinsurance. We believe that no exposure to a single reinsurer represents an inappropriate concentration of credit risk to AIG. Gross
* Net of reductions in DAC of $842 million, $583 million, and $1.4 billion at December 31, 2016, 2015 and 2014, respectively, related to the effect of net unrealized gains and losses on available for sale securities (shadow DAC).
The percentage of the unamortized balance of VOBA at December 31, 2016 expected to be amortized in 2017 through 2021 by year is: 8.6 percent, 7.9 percent, 7.2 percent, 6.8 percent and 6.2 percent, respectively, with 63.3 percent being amortized after five years.
ITEM 8 | Notes to Consolidated Financial Statements | 9. Deferred Policy Acquisition Costs
We enter into various arrangements with VIEs in the normal course of business and consolidate the VIEs when we determine we are the primary beneficiary. This analysis includes a review of the VIE’s capital structure, related contractual relationships and terms, nature of the VIE’s operations and purpose, nature of the VIE’s interests issued and our involvement with the entity. When assessing the need to consolidate a VIE, we evaluate the design of the VIE as well as the related risks the entity was designed to expose the variable interest holders to.
(c) At December 31, 2016 and 2015, off-balance sheet exposure primarily consisting of commitments to real estate and investment entities was $106 million and $131 million, respectively.
and $1.6 billion at December 31, 2016 and 2015, respectively. In the case of collateral provided to us under derivative transactions that are not subject to clearing, we generally can repledge or resell collateral.
The following table presents the effect of derivative instruments not designated as hedging instruments in the Consolidated Statements of Income:
We estimate that at December 31, 2016, based on our outstanding financial derivative transactions, a downgrade of our long-term senior debt ratings to BBB+, BBB or BBB- by Standard & Poor’s Financial Services LLC, a subsidiary of S&P Global Inc., and/or a downgrade to Baa2 or Baa3 by Moody’s Investors’ Service, Inc. would permit counterparties to make additional collateral calls and permit certain counterparties to elect early termination of contracts, resulting in corresponding collateral postings and termination payments in the total amount of up to approximately $106 million.
We elect to account for our investments in these hybrid securities with embedded written credit derivatives at fair value, with changes in fair value recognized in Net investment income and Other income. Our investments in these hybrid securities are reported as Other bond securities in the Consolidated Balance Sheets. The fair values of these hybrid securities were $4.8 billion and $5.7 billion at December 31, 2016 and 2015, respectively. These securities have par amounts of $10.1 billion and $11.2 billion at December 31, 2016 and 2015, respectively, and have remaining stated maturity dates that extend to 2052.
The impairment assessment involves an option to first assess qualitative factors to determine whether events or circumstances exist that lead to a determination that it is more likely than not that the fair value of an operating segment is less than its carrying amount. If
ITEM 8 | Notes to Consolidated Financial Statements | 12. Goodwill
If the qualitative test is not performed or if the test indicates a potential impairment is present, we estimate the fair value of each operating segment and compare the estimated fair value with the carrying amount of the operating segment, including allocated goodwill. The estimate of an operating segment’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 an operating segment to be used in the impairment test.
Goodwill was not impaired at December 31, 2016 based on the results of the goodwill impairment test.
The following table presents the changes in goodwill by operating segment:
The following table presents the roll forward of activity in Loss Reserves:
Liability for unpaid loss and loss adjustment expenses, beginning of year
Changes in net liability for unpaid losses and loss adjustment expenses due to
• Higher than expected losses emerging across several casualty product lines, especially in the recent accident years (generally, 2011 to 2015) driven by increased frequency and severity of claims. This recent accident year loss emergence caused us to increase loss development factors applied across many accident years.
The Loss Development Tables below include loss development data by our major lines of business for the last 10 accident years. The drivers of prior year development are discussed following each of the Loss Development Tables.
The following is information about incurred and paid loss developments as of December 31, 2016, net of reinsurance. The cumulative number of reported claims, the total of IBNR liabilities and expected development on reported loss included within the net incurred loss amounts are presented in the following section.
• Expected Loss Ratio method: The Expected Loss Ratio method multiplies premiums by an expected loss ratio to produce ultimate loss estimates for each accident year. This method may be useful if loss development patterns are inconsistent, losses emerge very slowly, or there is relatively little loss history from which to estimate future losses.
• Bornhuetter-Ferguson method: The Bornhuetter-Ferguson method using premiums and paid losses is a combination of the Paid Development method and the Expected Loss Ratio method where the weights given to each method is the reciprocal of the loss development factor. This method normally determines expected loss ratios similar to the method used for the Expected Loss Ratio method. The Bornhuetter-Ferguson method using premiums and incurred losses is similar to the Bornhuetter-Ferguson method using premiums and paid losses except that it uses case incurred losses.
In updating our loss reserve estimates, we consider and evaluate inputs from many sources, including actual claims data, the performance of prior reserve estimates, observed industry trends, our internal peer review processes, including challenges and recommendations from our Enterprise Risk Management group, as well as the views of third party actuarial firms. We use these inputs to improve our evaluation techniques, and to analyze and assess the change in estimated ultimate loss for each accident year by product line. Our analyses produce a range of indications from various methods, from which we select our best estimate.
• an assessment of economic conditions, including real GDP growth, inflation, employment rates or unemployment duration, stock market volatility and changes in corporate bond spreads;
• underlying policy pricing, terms and conditions including attachment points and policy limits;
an occurrence basis. Primarily, all short-tail lines in Property and Special Risks and Personal Insurance are written on an occurrence basis.
• Incurred but not reported liabilities (IBNR): We include development from past reported losses in IBNR.
• Data excluded from tables: Information with respect to accident years older than ten years is excluded from the development tables. Unallocated loss adjustment expenses are also excluded.
• Foreign exchange: The loss development for operations outside of the U.S. is presented for all accident years using the current exchange rate at December 31, 2016. Although this approach requires restating all prior accident year information, the changes in exchange rates do not impact incurred and paid loss development trends.
• Claim counts: We consider a reported claim to be one claim for each claimant or feature for each loss occurrence. Claims relating to losses that are 100 percent reinsured are excluded from the reported claims in the tables below. Reported claims for losses from assumed reinsurance contracts are not available and hence not included in the reported claims.
- Claim counts are presented only on a reported (not an ultimate) basis;
Supplemental Information: The information about incurred and paid loss development for all periods preceding year ended December 31, 2016 and the related historical claims payout percentage disclosure is unaudited and is presented as supplementary information.
The following tables present undiscounted, incurred and paid losses and allocated loss adjustment expenses by accident year, on a net basis after reinsurance, for 10 years:
Many of our primary casualty policies contain risk-sharing features, including high deductibles, self-insured retentions or retrospective rating features, in addition to a traditional insurance component. These risk-sharing programs generally are large and complex, comprising multiple products, years and structures, and are subject to amendment over time. We group guaranteed cost and excess of deductible business separately and then further by state and industry subset to the extent that meaningful differences are determined to exist. We also separately analyze certain subsets of the portfolio that have unique characteristics (e.g., U.S. government sub-contractor accounts and construction wrap-up business). For excess of deductible business, we also segment by size of deductible and whether the claim is handled by AIG or an outside third party administrator (TPA).
During 2015, we increased our reserves by $234 million, primarily for accident years 2012 and prior in the U.S. Workers’ Compensation line, to reflect estimated increased losses and reduced expectations of future recoveries from our insureds through risk-sharing features. We also recognized $100 million of adverse prior year development in U.S. Workers’ Compensation coverages sold to government contractors in U.S. and non-U.S. military installations as a result of adverse loss emergence from several large accounts in the recent accident years. In addition, we reacted to the adverse emergence by increasing our expected loss ratios in recent accident years. For the remainder of the primary workers’ compensation portfolio, our 2015 analysis was based on the refined segmentation from 2014, and indicated that prior year loss reserve development was flat after taking into account the initiatives that our claim function had undertaken to manage high risk claims.
U.S. Excess Casualty policies tend to attach at a high layer above underlying policies, which causes the loss development pattern to be lagged significantly. Many of the claims notified to the excess layers are closed without payment because the claims never reach our layer as a result of high deductibles and other underlying coverages, while the claims that reach our layer and close with payment can be large and highly variable in terms of reported timing and amount. For a portion of this business, the underlying primary policies are issued by other insurance companies, which can limit our access to relevant information to help inform our judgments as the loss events evolve and mature.
During 2016, we recognized $1.1 billion of adverse development driven by continued higher than expected loss emergence due to increased frequency and severity in recent accident years for both automobile and general liability claims. Approximately $250 million of the adverse development is attributable to a cohort of commercial automobile claims identified in 2015 which continued to increase in severity in 2016 beyond what was observed or reasonably expected in 2015. The most significant increases in incurred losses were for accident years 2011 and subsequent. In particular, the frequency and severity of loss events for accident years 2011 and subsequent showed a significant step change from accident years 2010 and prior. We therefore gave limited credibility to accident year 2010 and prior in selecting our expected loss ratios for 2011 and subsequent accident years due to this shift in loss patterns that is now more evident and credible after examining 2016 data. As a result of the continued adverse emergence, we have increased our loss trend assumptions for general liability and automobile and increased our expected loss ratios for the most recent four accident years.
During 2015, U.S. Excess Casualty experienced $1.4 billion of adverse development largely driven by worse than expected loss emergence reported in 2015. This increase was largely driven by adverse emergence in both general liability and umbrella auto liability, reflecting worsening trends in the number and nature of high severity losses. Approximately $411 million of the adverse development is related to automobile liability. Based on the adverse emergence we updated our assumptions about loss severity, loss development patterns and expected loss ratios for the most recent accident years. We have seen an increasing trend in the frequency of high severity claims, especially in the umbrella automobile liability portfolio. We also observed deterioration in certain class action claims that have complex coverage uncertainties and high limits characterized by increases in new claims and/or demands reported in 2015 and progress towards potential settlements, which have further informed our actuarial projections of ultimate losses for these types of claims. These types of claim classes have the longest emergence period within the excess casualty class and can impact multiple accident years, and are therefore inherently more volatile. In addition, we also increased losses associated with bad-faith claims by approximately $120 million reflecting an increase in recent settlements.
During 2014, U.S. Excess Casualty experienced $106 million of favorable development largely driven by savings on a few large claims. In our excess umbrella analysis in 2014, our revised segmentation led to lower 2005 and subsequent accident year estimates for non-mass tort claims where we expect underwriting actions and reductions in policy limits to have a favorable effect on ultimate losses from accident years 2007 to 2013 in particular. This was entirely offset by higher selected ultimate losses for accident years 2004 and prior as a result of updated loss development patterns for mass tort claims which we segmented separately from the non-ultimate loss ratios of prior years, adjusted for rate changes, estimated loss cost trends and all other changes that can be quantified.
U.S Other Casualty includes general liability, commercial auto and medical malpractice.
We segment our analysis by line of business and key coverage structures (claims-made vs. occurrence, large deductible policies, retrospective-rated policies, captives, etc.). Additionally, certain subsets, such as construction defect for general liability, trucking policies for auto liability and hospital policies for medical malpractice and underground storage tanks for environmental are generally reviewed separately from business in other subsets. We continually refine our loss reserving techniques for the domestic primary
casualty product lines and adopt further segmentations based on our analysis of the differing emerging loss patterns for certain subsets of insureds. Due to the long-tail nature of general liability business, and the many subsets that are reviewed individually, there is less credibility given to the reported losses and increased reliance on expected loss ratio methods for recent accident years.
For certain product lines with sufficient loss volume, loss development methods may be given significant weight for all but the most recent one or two accident years. For smaller or more volatile subsets of business and excess of a large deductible business, loss development methods may be given limited weight for the five or more recent accident years. Expected loss ratio methods are used for the more recent accident years for these subsets. The loss experience for primary general liability business is generally reviewed at a level that is believed to provide the most appropriate data for reserve analysis. For other subsets, such as environmental, we utilize a combination of claim analysts’ loss projections and actuarial methods estimate ultimate losses.
For commercial auto liability in 2014, we reacted to an increase in frequency of large claims in the accident years 2010 to 2013, where the economic recovery has contributed to increased frequency and severity, especially for those claims in excess of a client deductible of $500,000, which generally take several years to emerge and settle. This led to adverse prior year loss reserve development of $156 million.
During 2014, we recognized $57 million of adverse development in U.S. Other Casualty hospitals coverages largely driven by three large and relatively unusual claims of $25 million each in relatively recent accident years. While there have not been any significant structural changes to the portfolio, there can be material volatility in loss experience in this class of business where individual claims can be of high severity.
U.S. Financial Lines business includes Directors and Officers (D&O), Errors and Omissions (E&O), Employment Practices Liability Insurance (EPLI) and various professional liability subsets of business, as well as the fidelity book of business. This includes cyber coverage, which has been a growing and evolving portion of this portfolio. These product lines are predominantly claims-made in nature, losses are characterized by low frequency and high severity, and results are often significantly impacted by external economic conditions.
Our analysis is segmented by major coverages, such as D&O, E&O, etc. and then further segmented by major industry groups (e.g. corporate accounts, national accounts, financial institutions, private/not-for-profit etc.) We also separately review primary business from excess business for certain product lines.
We generally use a combination of loss development methods and expected loss ratio methods for D&O, E&O, EPLI, and professional liability. These product lines generally are offered on a claims-made basis, and losses are characterized by low frequency and high severity. In general, expected loss ratio methods are given more weight in the more recent accident years, whereas loss development methods are given more weight in more mature accident years. The loss development factors for the different segments differ significantly in some cases, based on specific coverage characteristics and other factors such as industry group, attachment points, and limits offered. Individual claims projections for accident years 2015 and prior are also used in the analysis. For the more mature accident years, we have generally given more weight to the incurred and legal expense loss development methods than in prior years’ reviews.
During 2016, we recognized $306 million of adverse development as we reacted to the adverse actual versus expected in 2016 driven by higher than expected settlements on several large claims from the financial crisis for accident years 2006 to 2010, as well as adverse emergence of errors and omissions losses relative to historical expectations. In addition to the adverse emergence, we also updated our loss development factor assumptions, expected loss ratio assumptions and the weights given to the various methods in recent accident years.
During 2016, we recognized $355 million of adverse development in Europe Casualty and Financial Lines driven by continued higher than expected loss emergence. The net earned premium for Europe Casualty and Financial Lines has increased by approximately 8 percent from accident year 2011 to accident year 2016.
During 2015, we recognized $139 million of adverse prior year development, primarily due to primary casualty and professional liability in Continental Europe and the UK. During 2015, we implemented an enhanced claims operating model in Europe which has provided our actuaries with more detailed case reserve data and analysis, enabling AIG’s actuaries to react sooner to case development than in prior years.
During 2016, we recognized $402 million of adverse prior year development in the U.S. and Europe Property and Special Risks mainly due to the U.S. program product line which is a collection of programs offering package policies to small and middle market insureds.
We primarily segment our analysis by line of business (and by country for Europe business). Additionally, we separately review various subsets, including hull, cargo, and liability for marine business, aviation and satellite for aerospace business, and various other specific programs and product lines.
Frequency/severity methods, loss development methods, and IBNR factor methods are used alone or in combination to set reserves for short-tail classes such as U.S. and Europe Property.
During 2016, the adverse development of $402 million was driven by our U.S. program business where we recognized $350 million of adverse prior year development due to higher than expected claim emergence in certain automobile, habitational and professional liability programs that resulted in us increasing expected loss ratios and loss development factors for several program subsets. This was partially offset by favorable prior year development in Europe Special Risk. Property had favorable emergence of $62 million mainly driven by the Europe property segment.
We recognized $114 million of favorable prior year development in U.S., Europe and Japan Personal Insurance mainly due to international accident and health business.
U.S., Europe and Japan Personal Insurance lines consist of accident and health and other personal lines. Accident and health products include voluntary and sponsor-paid personal accident and supplemental health products for individuals, employees, associations and other organizations as well as a broad range of travel insurance products and services for leisure and business travelers. Other personal lines include automobile and homeowners’ insurance, extended warranty, and consumer specialty products, such as identity theft and credit card protection. Other personal insurance also provides insurance for high net worth individuals offered through AIG Private Client Group, including auto, homeowners, umbrella, yacht, fine art and collections insurance. Other personal lines are generally short-tail in nature.
During 2016, 2015 and 2014, we recognized $114 million, $47 million, and $89 million of favorable development, respectively, mainly driven by the international accident and health business.
During 2016, 2015 and 2014, we experienced favorable loss reserve development of $3 million, $10 million and $16 million, respectively, from natural catastrophes.
Cumulative Paid Losses and Allocated Loss Adjustment Expenses, Net of Reinsurance from the table
Liabilities for losses and loss adjustment expenses and prior year development before 2007, net of reinsurance
U.S. Run-Off Long Tail Insurance lines includes run-off lines for asbestos and environmental (1986 and prior), excess workers’ compensation, and other casualty coverages consisting of environmental liability, medical malpractice, and general liability. Asbestos coverage has been excluded from AIG polices commencing in 1985. Most of AIG’s asbestos claims exposures are ceded to National Indemnity Company (NICO) under a retroactive reinsurance arrangement entered into in 2011. Many of other asbestos-related exposures are very long-tailed in nature and with exposures dating back 30 years or more. In some cases, the exposures in the more recent years have declined since the portfolio is in run-off.
U.S. Long Tail Insurance lines - Asbestos and Environmental (1986 and prior)
• claims filed under the non-aggregate premises or operations section of general liability policies;
• the number of insureds seeking bankruptcy protection and the effect of prepackaged bankruptcies;
• the difficulty in estimating the allocation of remediation cost among various parties with respect to environmental claims.
During 2015, the reported claim activity on the assumed claims increased. We responded to this by modifying certain of our loss-reserve-related assumptions to better reflect our loss development. Additionally, we considered recent industry-wide trends regarding expanding coverage theories for liability. In 2015, both the retained accounts and retroceded accounts ground-up reviews for asbestos were updated. As a result, we increased gross undiscounted asbestos incurred losses by $13 million and increased net undiscounted asbestos incurred losses by $164 million. The net undiscounted change reflects an increase primarily due to third party assumed reinsurance exposures. With the gross incurred loss increase less than the net incurred loss increase, the resulting ceded incurred losses were reduced. For environmental, we increased gross environmental incurred losses by $214 million and net environmental incurred losses by $117 million as a result of top down actuarial analyses performed during the year, as well as development on a large sediment site.
During 2016 and 2015, we did not experience significant development in the loss development trends. The proactive management of settlement negotiations and other claims mitigation strategies minimized the volatility observed during 2015. The nominal reduction in reserves as a result of commutations and individual claims settlement strategies amounted to $222 million in 2015 compared to $242 million in 2014.
During 2014, we updated our analyses of run-off excess workers’ compensation lines using a range of scenarios and methodologies and determined that our carried reserves were adequate after recognizing $20 million of favorable prior year development resulting from claim settlements and commutations on our assumed reinsurance business, as well as reflecting changes in estimates in our loss mitigation strategies. We commuted several large assumed reinsurance agreements in 2014 and reduced the reserves faster than was previously expected as a result of proactive management by the run-off unit.
Other Casualty Run-Off. We increased the reserves for these coverages by $190 million and $636 million during 2016 and 2015, respectively, to reflect updated assumptions about future loss development. The 2016 increase was driven by runoff public entity business where we reacted to the adverse emergence over the last year by increasing our loss development factors to reflect its own experience especially in the loss tail instead of relying on the overall excess casualty loss development factors.
The previous development tables include only accident years 2007 to 2016. The following table summarizes development, (favorable) or unfavorable, of incurred losses and loss adjustment expenses for accident year 2006 and prior by operating segment and major class of business:
At December 31, 2016, the loss reserves reflect a net loss reserve discount of $3.6 billion, including tabular and non-tabular calculations based upon the following assumptions:
The non-tabular workers’ compensation discount is calculated separately for companies domiciled in New York and Pennsylvania, and follows the statutory regulations (prescribed or permitted) for each state. For New York companies, the discount is based on a 5 percent interest rate and the companies’ own payout patterns. In 2012, for Pennsylvania companies, the statute has specified discount factors for accident years 2001 and prior, which are based on a 6 percent interest rate and an industry payout pattern. For accident years 2002 and subsequent, the discount is based on the payout patterns and investment yields of the companies.
In 2013, our Pennsylvania regulator approved use of a consistent discount rate (U.S. Treasury rate plus a liquidity premium) to all of our workers’ compensation reserves in our Pennsylvania-domiciled companies, as well as our use of updated payout patterns specific to our primary and excess workers compensation portfolios.
In the fourth quarter of 2016, our Pennsylvania and Delaware regulators approved an updated discount rate that we applied to our workers’ compensation loss reserves for the legal entities domiciled in those states.
The discount consists of $932 million of tabular discount for workers’ compensation and $2.6 billion of non-tabular discount for workers’ compensation. During the years ended December 31, 2016, 2015 and 2014 the benefit/(charge) from changes in discount of $422 million, $71 million and $(478) million, respectively, were recorded as part of the policyholder benefits and losses incurred in the Consolidated Statement of Income.
During 2016, effective interest rates declined due to a decrease in the forward yield curve component of the discount rates reflecting a decline in U.S. Treasury rates along the changes in payout pattern assumptions. This resulted in a decrease in the loss reserve discount by $106 million.
During 2014, the effective interest rate decreased due to the decrease in Treasury rates along with changes in payout pattern assumptions that resulted in a decrease in the loss reserve discount by $397 million.
On January 1, 2014, we merged two internal pooling arrangements of our U.S. Property Casualty companies into one pool, and changed the participation percentages of the pool members resulting in a reallocation of loss reserves from New York-domiciled companies to those domiciled in Pennsylvania and Delaware. As a result of these changes in the participation percentages and domiciliary states of the participants of the combined pool, we recognized a discount benefit of $110 million in the first quarter of 2014.
Future policy benefits also include certain guaranteed benefits of variable annuity products that are not considered embedded derivatives, primarily guaranteed minimum death benefits. See Note 14 for additional information on guaranteed minimum death benefits.
The liability for Policyholder contract deposits is primarily recorded at accumulated value (deposits received and net transfers from separate accounts, plus accrued interest credited at rates ranging from 0.2 percent to 9.0 percent at December 31, 2016, less withdrawals and assessed fees). Deposits collected on investment-oriented products are not reflected as revenues, because they are recorded directly to Policyholder contract deposits upon receipt. Amounts assessed against the contract holders for mortality, administrative, and other services are included in revenues.
Policy values for variable products and investment contracts are expressed in terms of investment units. Each unit is linked to an asset portfolio. The value of a unit increases or decreases based on the value of the linked asset portfolio. The current liability at any time is the sum of the current unit value of all investment units in the separate accounts, plus any liabilities for guaranteed minimum death benefits or guaranteed minimum withdrawal benefits included in Future policy benefits or Policyholder contract deposits, respectively.
Depending on the contract, the GMDB feature may provide a death benefit of either (a) total deposits made to the contract less any partial withdrawals plus a minimum return (and in rare instances, no minimum return) or (b) the highest contract value attained, typically on any anniversary date minus any subsequent withdrawals following the contract anniversary. GMIB guarantees a minimum level of periodic income payments upon annuitization. GMDB is our most widely offered benefit. Our account values subject to guarantees also include GMIB to a lesser extent, which is no longer offered.
Certain of our variable annuity contracts contain optional GMWB benefits and, to a lesser extent, GMAB benefits, which are not currently offered. With a GMWB, the contract holder can monetize the excess of the guaranteed amount over the account value of the contract only through a series of withdrawals that do not exceed a specific percentage per year of the guaranteed amount. If, after the series of withdrawals, the account value is exhausted, the contract holder will receive a series of annuity payments equal to the
Our long-term debt is denominated in various currencies, with both fixed and variable interest rates. Long-term debt is carried at the principal amount borrowed, including unamortized discounts, hedge accounting valuation adjustments and fair value adjustments, when applicable. The interest rates presented in the following table reflect the range of contractual rates in effect at December 31, 2016, including fixed and variable rate issuances.
(a) AIG Parent guarantees all such debt, except for MIP notes payable and Series AIGFP matched notes and bonds payable, which are direct obligations of AIG Parent. Collateral posted to third parties was $2.2 billion and $2.4 billion at December 31, 2016 and December 31, 2015, respectively. This collateral primarily consists of securities of the U.S. government and government sponsored entities and generally cannot be repledged or resold by the counterparties.
(b) At December 31, 2016, includes debt of consolidated investment vehicles related to real estate investments of $1.9 billion, affordable housing partnership investments of $1.7 billion and other securitization vehicles of $771 million. At December 31, 2015, includes debt of consolidated investment vehicles related to real estate investments of $2.4 billion, affordable housing partnership investments of $1.5 billion and other securitization vehicles of $1.0 billion.
ITEM 8 | Notes to Consolidated Financial Statements | 15. Debt
The following table presents maturities of long-term debt (including unamortized original issue discount, hedge accounting valuation adjustments and fair value adjustments, when applicable), excluding $4.4 billion in borrowings of debt of consolidated investments:
Overview. In the normal course of business, AIG and our subsidiaries are, like others in the insurance and financial services industries in general, subject to litigation, including claims for punitive damages. In our insurance operations, litigation arising from claims settlement activities is generally considered in the establishment of our loss reserves. However, the potential for increasing jury awards and settlements makes it difficult to assess the ultimate outcome of such litigation. AIG is also subject to derivative, class action and other claims asserted by its shareholders and others alleging, among other things, breach of fiduciary duties by its directors and officers and violations of insurance laws and regulations, as well as federal and state securities laws. In the case of any derivative action brought on behalf of AIG, any recovery would accrue to the benefit of AIG.
On March 27, 2015, an additional securities action was filed in state court in Orange County, California asserting a claim against AIG pursuant to Section 11 of the Securities Act (the California Action) that is substantially similar to those in the Consolidated 2008
We have accrued our current estimate of probable loss with respect to these litigations.
On November 21, 2011, Starr International Company, Inc. (SICO) filed a complaint against the United States in the United States Court of Federal Claims (the Court of Federal Claims), bringing claims, both individually and on behalf of the classes defined below and derivatively on behalf of AIG (the SICO Treasury Action). The complaint challenges the government’s assistance of AIG, pursuant to which AIG entered into a credit facility with the Federal Reserve Bank of New York (the FRBNY, and such credit facility, the FRBNY Credit Facility) and the United States received an approximately 80 percent ownership in AIG. The complaint alleges that the interest rate imposed on AIG and the appropriation of approximately 80 percent of AIG’s equity was discriminatory, unprecedented, and inconsistent with liquidity assistance offered by the government to other comparable firms at the time and violated the Equal Protection, Due Process, and Takings Clauses of the U.S. Constitution.
On March 11, 2013, the Court of Federal Claims in the SICO Treasury Action granted SICO’s motion for class certification of two classes with respect to SICO’s non-derivative claims: (1) persons and entities who held shares of AIG Common Stock on or before September 16, 2008 and who owned those shares on September 22, 2008 (the Credit Agreement Shareholder Class); and (2) persons and entities who owned shares of AIG Common Stock on June 30, 2009 and were eligible to vote those shares at AIG’s June 30, 2009 annual meeting of shareholders (the Reverse Stock Split Shareholder Class). SICO has provided notice of class certification to potential members of the classes, who, pursuant to a court order issued on April 25, 2013, had to return opt-in consent forms by September 16, 2013 to participate in either class. 286,908 holders of AIG Common Stock during the two class periods have opted into the classes.
ITEM 8 | Notes to Consolidated Financial Statements | 16. Contingencies, Commitments and Guarantees
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 direction of the NAIC’s Market Analysis Working Group. AIG was informed of the multi-state targeted market conduct examination in January 2008. The lead states in the multi-state examination were Delaware, Florida, Indiana, Massachusetts, Minnesota, New York, Pennsylvania and Rhode Island. All other states (and the District of Columbia) agreed to participate in the multi-state examination. The examination focused on legacy issues related to certain AIG entities’ writing and reporting of workers compensation insurance between 1985 and 1996.
On December 17, 2010, AIG and the lead states reached an agreement to settle all regulatory liabilities arising out of the subjects of the multistate examination. This regulatory settlement agreement, which was agreed to by all 50 states and the District of Columbia, included, among other terms, (i) AIG’s payment of $100 million in regulatory fines and penalties; (ii) AIG’s payment of $46.5 million in outstanding premium taxes and assessments; (iii) AIG’s agreement to enter into a compliance plan describing agreed-upon specific steps and standards for evaluating AIG’s ongoing compliance with state regulations governing the setting of workers’ compensation insurance premium rates and the reporting of workers’ compensation premiums; and (iv) AIG’s agreement to pay up to $150 million in contingent fines in the event that AIG fails to comply substantially with the compliance plan requirements. In furtherance of the compliance plan, the agreement provided for a monitoring period from May 29, 2012 to May 29, 2014 leading up to a compliance plan examination. After the close of the monitoring period, as part of preparation for the actual conduct of the compliance plan examination, on or about October 1, 2014, AIG and the lead states agreed upon corrective action plans to address particular issues identified during the monitoring period. The compliance plan examination is ongoing. There can be no assurance that the result of the compliance plan examination will not result in a fine, have a material adverse effect on AIG’s ongoing operations or lead to civil litigation.
Rent expense was $331 million, $327 million and $471 million for the years ended December 31, 2016, 2015 and 2014, respectively.
We are subject to financial guarantees and indemnity arrangements in connection with the completed sales of businesses pursuant to our asset disposition plan. The various arrangements may be triggered by, among other things, declines in asset values, the occurrence of specified business contingencies, the realization of contingent liabilities, developments in litigation or breaches of representations, warranties or covenants provided by us. These arrangements are typically subject to various time limitations, defined by the contract or by operation of law, such as statutes of limitation. In some cases, the maximum potential obligation is subject to contractual limitations, while in other cases such limitations are not specified or are not applicable.
• See Note 10 to the Consolidated Financial Statements for additional discussion on commitments and guarantees associated with VIEs.
• See Note 11 to the Consolidated Financial Statements for additional disclosures about derivatives.
• See Note 25 to the Consolidated Financial Statements for additional disclosures about guarantees of outstanding debt.
Payment of future dividends to our shareholders and repurchases of AIG Common Stock depends in part on the regulatory framework that we are currently subject to and that will ultimately be applicable to us, including as a nonbank systemically important financial institution under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) and a global systemically important insurer. In addition, dividends are payable on AIG Common Stock only when, as and if declared by our Board of Directors in its discretion, from funds legally available for this purpose. In considering whether to pay a dividend or purchase shares of AIG Common Stock, our Board of Directors considers a number of factors, including, but not limited to: the capital resources available to support our insurance operations and business strategies, AIG’s funding capacity and capital resources in comparison to internal benchmarks, expectations for capital generation, rating agency expectations for capital, regulatory standards for capital and capital distributions, and such other factors as our Board of Directors may deem relevant.