We operate from approximately 400 offices in the United States and approximately 500 offices in over 75 foreign countries. The following offices are located in buildings in the United States owned by us:
In addition, Non-Life Insurance Companies own offices in approximately 20 foreign countries and jurisdictions including Argentina, Bermuda, Colombia, Ecuador, Japan, Mexico, the U.K., Taiwan, and Venezuela. The remainder of the office space we utilize is leased. We believe that our leases and properties are sufficient for our current purposes.
As of December 31, 2014, approximately 10 percent of our consolidated assets were located outside the U.S. and Canada, including $608 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 amounts of cash and securities deposited by our insurance subsidiaries under requirements of regulatory authorities.
(b) Book value per share, excluding Accumulated other comprehensive income (loss) is a non-GAAP measure. See
/ MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
• the timing and applicable requirements of any new regulatory framework to which we are subject as a nonbank systemically important financial institution (SIFI) and as a global systemically important insurer (G-SII);
We are not under any obligation (and expressly disclaims any obligation) to update or alter any projections, goals, assumptions or other statements, whether written or oral, that may be made from time to time, whether as a result of new information, future events or otherwise.
Throughout the MD&A, we use certain terms and abbreviations which are summarized in the Glossary and Acronyms.
• changes in fair value of fixed maturity securities designated to hedge living benefit liabilities (net of interest expense);
• gain on the sale of International Lease Finance Corporation (ILFC); and
We use the following operating performance measures within our Commercial Insurance and Consumer Insurance reportable segments as well as Corporate and Other.
• Commercial Insurance: Property Casualty and Mortgage Guaranty; Consumer Insurance: Personal Insurance
· Pre-tax operating income: includes both underwriting income and loss and net investment income, but excludes net realized capital gains and losses, other income and expense - net and legal settlements related to legacy crisis matters described above. Underwriting income and loss is derived by reducing net premiums earned by losses and loss adjustment expenses incurred, acquisition expenses and general operating expenses.
• changes in benefit reserves and DAC, VOBA and SIA related to net realized capital gains and losses; and
• changes in benefit reserves and DAC, VOBA and SIA related to net realized capital gains and losses;
• net gain or loss on sale of divested businesses, including:
• certain legal reserves (settlements) related to legacy crisis matters described above.
Results from discontinued operations are excluded from all of these measures.
This overview of the MD&A highlights selected information and may not contain all of the information that is important to current or potential investors in AIG’s securities. You should read this Annual Report on Form 10-K in its entirety for a complete description of events, trends, uncertainties, risks and critical accounting estimates affecting us.
In the fourth quarter of 2014, we completed our previously announced reorganization of our commercial and consumer insurance businesses and modified the presentation of our results to reflect our new operating structure. The new operating structure includes two reportable segments, Commercial Insurance and Consumer Insurance, and a Corporate and Other category. The Corporate and Other category consists of businesses and items not allocated to our reportable segments. Prior to the fourth quarter of 2014, we reported our results through two reportable segments - AIG Property Casualty and AIG Life and Retirement.
In order to align financial reporting with the manner in which our chief operating decision makers review the businesses to assess performance and make decisions about resources to be allocated, the Commercial Insurance and Consumer Insurance reportable segments include the following operating segments:
• Commercial property casualty, mortgage guaranty and institutional markets businesses, which were previously reported as components of AIG Property Casualty, Other operations and AIG Life and Retirement, respectively, are now reported as components of the Commercial Insurance reportable segment.
Commercial Insurance pre-tax operating income increased in 2014 compared to 2013 primarily due to improved underwriting results in the Property Casualty and Mortgage Guaranty operating segments partially offset by reduced net investment income in the Property Casualty and Institutional Markets operating segments.
Net investment income improved in 2014 compared to 2013 due to positive performance on bonds for which we elected the fair value option, driven by interest rate movements. While corporate debt securities represented the core of new investment allocations, we continued to make investments in structured securities and other fixed income securities with favorable risk versus return characteristics to improve yields and increase net investment income.
We reduced our debt in 2014 as a result of maturities, repayments and repurchases of $16.1 billion, of which $7.5 billion is related to DIB redemptions and repurchases.
Our Board of Directors increased our share repurchase authorization of AIG Common Stock, par value $2.50 per share (AIG Common Stock), by an additional $2.5 billion on February 12, 2015. During 2014, we repurchased approximately 88 million shares of AIG Common Stock for an aggregate purchase price of approximately $4.9 billion. The total number of shares of AIG Common Stock repurchased in 2014, and the aggregate purchase price of these shares, reflect our payment of approximately $3.1 billion in the aggregate under five accelerated stock repurchase (ASR) agreements and our receipt of approximately 53 million shares of AIG Common Stock in the aggregate, including the initial receipt of 70 percent of the total notional share equivalent, or approximately 9.2 million shares of AIG Common Stock, under an ASR Agreement executed in December 2014.
We received net cash proceeds of approximately $2.4 billion from the sale of ILFC after taking into account the settlement of intercompany loans. This cash amount is in addition to the 97.6 million newly issued AerCap common shares we received as consideration from the sale.
Interest rates remain low relative to historical levels, which has affected our industry by reducing investment returns. In addition, current market conditions may not necessarily permit insurance companies to increase pricing across all our product lines.
Commercial Insurance expects the current low interest rate environment relative to historical levels, currency volatility, and ongoing uncertainty in global economic conditions will continue to challenge the growth of net investment income and limit growth in some markets. Due to these conditions and overcapacity in the property casualty insurance industry, Commercial Insurance has sought to modify terms and conditions, grow profitable segments of the business, exit unprofitable businesses and develop advanced data analytics to improve profitability.
Since the second quarter of 2014, within the U.S. commercial property business, Property Casualty observed continued rate pressure in the U.S. Excess and Surplus lines market, particularly with respect to its natural catastrophe exposed business. Property Casualty continues to differentiate its capacity from its peers through leveraging management’s significant experience with catastrophic events, providing loss prevention expertise and maintaining discipline in pricing to internal targets despite intense competition.
Mortgage Guaranty also expects that newly reported delinquencies will decline during 2015. Mortgage Guaranty believes the combination of higher persistency and lower new delinquencies, partially offset by a decline in new mortgage loan volumes, will result in favorable operating results for 2015.
Institutional Markets is expected to continue growing its assets under management from increased stable value wrap business, as well as from disciplined growth through the pursuit of select opportunities related to pension buyouts and GICs.
Institutional Markets is expected to continue contributing to growth in assets under management with stable value wraps and utilizing a disciplined approach to growth and diversification of our business by pursuing select opportunities in areas such as the pension buyout business.
We continue to further enhance our risk selection process and refine technical pricing and producer management, through enhanced tools and analytics. In addition, we remain focused on managing exposure to capital intensive long-tail lines. We believe that accident year loss ratios, as adjusted, will continue to improve due to these actions.
An increasing population of Americans expecting to live longer and placing less reliance on traditional retirement benefits are seeking financial security as they approach retirement, which continues to drive demand for individual variable and fixed index annuities with guaranteed income features. In addition, rising tax rates and a desire for higher investment returns have prompted less risk-averse investors to seek products without guaranteed lifetime income, providing Retirement Income Solutions the opportunity to further diversify its product portfolio by offering investment-focused variable annuities.
Despite the challenging environment where long-term interest rates have continued to remain low relative to historical levels throughout 2014, fixed annuity industry sales have continued to improve from the very low levels seen in 2013, as baby boomers approaching retirement continue to seek financial solutions that can provide guaranteed income, and customers are now more willing to purchase non-guaranteed return of premium products with market value adjustments in exchange for higher crediting rates. Although rapidly rising interest rates could create the potential for increased surrenders, customers are currently buying fixed annuities with longer surrender periods in pursuit of higher returns.
We intend to expand relationships with key distribution partners to fully realize the benefits of our diverse product offerings across multiple channels. Our focus on ease of doing business for consumers and producers includes enhancements to our platforms and services, as well as initiatives to improve the recruitment, training and productivity of our affiliated and non-affiliated distribution partners.
We intend to continue to strengthen our direct marketing capabilities through the use of analytics, stronger platforms and tools, an enhanced product portfolio and expanded relationships allowing us to bring more product solutions to our target markets.
Life will continue to invest to position for growth and serve its customers more effectively, and maintain pricing discipline in its overall strategy. Internationally, Life intends to expand its business in Japan, the United Kingdom and certain other countries through a focused strategy in selected markets and products by combining global expertise with local market intelligence to meet the needs of consumers in these target markets.
As part of our strategy to expand consumer operations in growth economies, on May 29, 2013, we entered into a joint venture agreement with PICC Life Insurance Company Limited (PICC Life), a subsidiary of the PICC Group, to form an agency distribution company in China to distribute life and retirement products. The joint venture company distributes PICC Life products and PICC Property & Casualty Company Limited (PICC P&C) insurance products, as well as other products aimed at meeting the needs of this developing market, and will distribute jointly developed life, retirement and personal insurance products. We own 24.9 percent of the joint venture company and PICC Life holds the remaining 75.1 percent. The joint venture commenced operations in March 2014.
Our investment objective is to maintain a diversified, high quality portfolio of fixed maturity securities having weighted average durations that are matched to the duration and cash flow profile of our liabilities, to the extent practicable. Our investment strategy is to maximize net investment income and portfolio value, subject to liquidity requirements, capital constraints, diversification requirements, asset-liability matching and available investment opportunities. See Investments for additional discussion of investment strategies.
For the year ended December 31, 2012, 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 decreases in the U.S. Life Insurance Companies’ capital loss carryforward valuation allowance of $1.9 billion related to the actual and projected gains from the U.S. Life Insurance Companies’ available-for-sale securities, and tax effects associated with tax exempt interest income of $302 million. These items were partially offset by changes in uncertain tax positions of $446 million.
The following table presents a reconciliation of net income attributable to AIG to after-tax operating income attributable to AIG:
After-tax operating income attributable to AIG for 2014 was essentially flat compared to 2013, primarily due to higher income tax expense, partially offset by an increase in income from insurance operations.
For the year ended December 31, 2014, the effective tax rate on pre-tax operating income was 30.9 percent. The significant factors that contributed to the difference from the statutory rate included tax benefits resulting from tax exempt interest income and other permanent tax items, and the impact of discrete tax benefits.
For the year ended December 31, 2013, the effective tax rate on pre-tax operating income was 28.8 percent. The significant factors that contributed to the difference from the statutory rate included tax benefits resulting from tax exempt interest income and other permanent tax items, and the impact of discrete tax benefits.
For the year ended December 31, 2012, the effective tax rate on pre-tax operating income was 31.6 percent. The difference from the statutory rate was primarily due to tax exempt interest income and other permanent tax items.
The following table summarizes the operations of each reportable segment and Corporate and Other. See also Note 3 to the Consolidated Financial Statements.
* Certain 2013 severance expenses for Commercial Insurance and Consumer Insurance are included in Corporate & Other. As these expenses, which total $263 million, are related to an overall AIG initiative to centralize work streams into lower cost locations, and create a more streamlined organization, they have not been allocated to the operating segments.
Pre-tax income increased in 2014 compared to 2013 primarily due to an increase in pre-tax operating income for Commercial Insurance, a $2.3 billion increase in income from divested businesses associated with the gain recognized upon completion of the sale of ILFC in 2014 and lower loss recognition expense reported in changes in benefit reserves and DAC, VOBA, and SIA related to net realized capital gains. These increases were partially offset by higher loss on extinguishment of debt from on-going debt management activities, a decrease in net realized capital gains driven by lower gains from sales of investments related to capital loss carryforward utilization in 2013, and a decrease in legal settlements with financial institutions that participated in the creation, offering and sale of RMBS from which we realized losses during the financial crisis.
The change in the fair value of GMWB and GMAV embedded policy derivatives, net of the change in fair value of all related economic hedges, resulted in a $149 million decrease in pre-tax income in 2014 compared to 2013. In 2014, we reduced our exposure to interest rate changes and consequently, the increase in the embedded policy derivative liability in 2014 was largely offset by the change in the fair value of related hedges. In 2013, pre-tax income increased due to the decrease in the embedded policy derivative liability driven by an increase in interest rates, which was only partially offset by hedging. The changes in fair value of the embedded policy derivatives and the majority of the related economic hedges are reported in Net realized gains (losses), and the change in fair value of certain U.S. Treasury bonds which hedge interest rate risk are reported in Change in fair value of certain fixed maturity securities designated to hedge living benefit liabilities.
The increase in pre-tax income in 2014 compared to 2013 included an increase due to lower changes in certain benefit reserves, DAC, VOBA and SIA related to net realized capital gains, which was primarily comprised of loss recognition expense in the Institutional Markets and Retirement operating segments, totaling $30 million in 2014 and $1.5 billion in 2013, attributable primarily to investment sales related to capital loss carryforward utilization with reinvestment of the sales proceeds at lower yields. Changes in certain benefit reserves, DAC, VOBA and SIA related to net realized capital gains also included loss recognition expense in Corporate and Other of $140 million in 2014 and $98 million in 2013.
The aggregate change in the fair value of GMWB and GMAV embedded policy derivatives net of the change in fair value of all related economic hedges, reported within Net realized capital gains (losses) and Change in fair value of fixed maturity securities designated to hedge living benefit liabilities, resulted in a $719 million increase in pre-tax income in 2013 compared to 2012, primarily due to the increase in interest rates.
For Commercial Insurance - Property Casualty and Consumer Insurance - Personal Insurance, we estimate investable funds based primarily on loss reserves, unearned premiums and a capital allocation for each operating segment. The net investment income allocation is calculated based on the estimated investable funds and risk-free yields (plus a liquidity premium) consistent with the approximate duration of the liabilities, and excludes net investment income associated with the run-off insurance lines reported in Corporate and Other. The remaining excess is attributed to Commercial Insurance - Property Casualty and Consumer Insurance - Personal Insurance based on the relative net investment income previously allocated.
Pre-tax operating income increased in 2014 compared to 2013 due to decreases in underwriting loss, partially offset by a decrease in net investment income. The decrease in underwriting loss was primarily due to an increase in production, lower charges due to changes in discount for workers’ compensation reserves as discussed further under Insurance Reserves - Non-Life Insurance Companies- Discounting of Reserves, lower catastrophe losses and lower general operating expenses. The loss reserve discount charge decreased to $71 million in 2014 from $322 million in 2013. Catastrophe losses decreased to $602 million in 2014 from $710 million in 2013. These decreases were partially offset by higher adverse prior year loss reserve development in all lines of business except for Property, and an increase in current accident year losses reflecting higher frequency of non-severe losses in the Property and Specialty businesses. The current accident year losses for 2014 included 30 severe losses totaling $592 million compared to 27 severe losses totaling $569 million in the prior year. Net adverse prior year loss reserve development, including related premium adjustments, was $550 million and $294 million in 2014 and 2013, respectively, as discussed further under Insurance Reserves - Non-Life Insurance Companies - Net Loss Development.
General operating expenses decreased in 2014 compared to 2013, primarily due to efficiencies from organizational realignment initiatives, partially offset by higher technology-related expenses and an increase in bad debt expense. In the prior year, general operating expenses benefitted from an unusually low bad debt expense.
Net investment income decreased in 2014 compared to 2013, primarily due to a decrease in interest rates during 2014, as yields on new purchases were lower than the weighted average yield of the overall portfolio, lower income on alternative investments, and lower income associated with investments accounted for under the fair value option, as the increase related to the PICC P&C rights offerings was more than offset by a decrease from fixed maturity investments accounted for under the fair value option. These were partially offset by the effect of continued portfolio diversification. Additionally, the decrease in allocated net investment income is also due to a reduction in net loss reserves.
Pre-tax operating income increased in 2013, compared to 2012, primarily due to a lower underwriting loss as a result of lower catastrophe losses, rate increases, enhanced risk selection and loss mitigation activities and an increase in net investment income. Catastrophe losses decreased to $710 million in 2013 from $2.3 billion in 2012. Partially offsetting these improvements was a loss reserve discount charge of $322 million in 2013, compared to a $100 million benefit in 2012. See Insurance Reserves- Non-Life Insurance Companies- Discounting of Reserves for further discussion. In addition, the current accident year losses for 2013 included severe losses of $569 million compared to $293 million in 2012. This increase was driven largely by a large property loss and related contingent business interruption claims, totaling $131 million in 2013 and by an increased frequency of severe losses in 2013 compared to 2012. Net adverse prior year loss reserve development increased by $30 million compared to 2012. Net adverse prior year loss reserve development, including related premium adjustments was $294 million in 2013, which included $149 million of adverse prior year loss reserve development related to Storm Sandy, compared to $236 million in 2012. The adverse prior year loss reserve development related to Storm Sandy resulted from higher severities on a small number of existing large and complex commercial claims. These increased severities were driven by a number of factors, including the extensive damage caused to properties in the downtown New York metropolitan area.
Acquisition expenses decreased in 2013, compared to 2012, due to changes in reinsurance, the timing of guaranty funds and other assessments, as well as change in business mix.
Property Casualty net premiums written increased in 2014 compared to 2013, reflecting increases in new business related to targeted growth products in Property and Financial lines.
Gulf of Mexico and Caribbean named storms, and U.S. and Canadian earthquakes. To fund its potential obligations to us, Tradewynd Re Ltd. issued three tranches of notes. The transaction provides Property Casualty and Personal Insurance with fully collateralized coverage against losses from those events on a per-occurrence basis through December 2016. Catastrophe bond reinsurance transactions reduced net premiums written by $56 million and $140 million in 2014 and 2013, respectively.
Specialty net premiums written decreased slightly in 2014, compared to 2013 primarily reflecting lower retention and rate decline in the EMEA region. This decline was largely offset by new business increases related to targeted growth products, including growth in small- and medium-sized enterprise markets in the Americas region.
Financial lines net premiums written increased in 2014, compared to 2013 reflecting growth in new business related to targeted growth products across all regions, as well as a favorable rate environment in the U.S.
Casualty net premiums written decreased in 2013, compared to 2012, primarily due to the execution of our strategy to enhance risk selection, particularly in the Americas and EMEA, as well as to increase specific reinsurance purchases to better manage our exposures. Changes in reinsurance strategy decreased net premiums written by approximately $185 million in 2013, compared to 2012. We implemented rate increases in retained business, especially in the U.S., that partially offset these premium decreases.
Property net premiums written increased in 2013, compared to 2012, primarily due to growth in new business across all regions, favorable retention in renewal businesses and increases in coverage limits and changes to our per-risk reinsurance program to retain more favorable risks, while continuing to manage aggregate exposure. Catastrophe-exposed businesses in the Americas also benefitted from rate increases.
Specialty net premiums written increased in 2013 compared to 2012, primarily due to rate increases in environmental business, small-and medium-sized enterprise markets in the Americas region, and new business growth in EMEA. Additionally, the restructuring of our reinsurance program to retain more favorable risks while continuing to manage aggregate exposure, increased net premiums written by $144 million in 2013, compared to 2012.
Financial lines net premiums written increased in 2013 compared to 2012, reflecting growth in new business related to targeted growth products, particularly in the EMEA region as well as an improved rate environment globally. Global professional indemnity net premiums written increased by $86 million in 2013 compared to 2012, due to improved rates, strong new business growth and the restructuring of our reinsurance program, as part of our decision to retain more favorable risks while continuing to manage aggregate exposure.
The following table presents Property Casualty’s net premiums written by region:
The Americas net premiums written decreased in 2014 compared to 2013, primarily due to declines in new business growth and rate pressure, particularly in the Casualty business. However, for 2014, the decrease in net premiums written was partially offset by lower ceded premiums from catastrophe reinsurance transactions described above in 2014 compared to 2013.
Asia Pacific net premiums written decreased slightly in 2014 compared to 2013, primarily due to the strengthening of the U.S. dollar against the Japanese yen. Excluding the effect of foreign exchange, net premiums written increased primarily due to increases in targeted growth products, and changes to optimize our reinsurance structure as part of our decision to retain more favorable risks while continuing to manage aggregate exposure, particularly in Japan.
EMEA net premiums written increased in 2014 compared to 2013, due to new business growth across all lines of businesses, except for Specialty.
The following tables present the Property Casualty combined ratios based on GAAP data and reconciliation to the accident year combined ratio, as adjusted:
The following tables present Property Casualty’s accident year catastrophe and severe losses by region and number of events:
The acquisition ratio decreased by 0.4 points in 2014 compared to 2013, primarily due to a reduction in expenses of personnel engaged in sales support activities, lower premium taxes and guaranty fund and other assessments.
The general operating expense ratio decreased by 0.7 points in 2014 compared to 2013, primarily due to efficiencies from organizational realignment initiatives, partially offset by higher technology-related expenses and an increase in bad debt expense. In 2013, general operating expenses benefitted from an unusually low bad debt expense.
The improvement in the accident year loss ratio, as adjusted, reflects the realization of benefits from the continued execution of our strategy to enhance risk selection, pricing discipline, exposure management and claims processing. Although the execution of these strategies resulted in a reduction of Casualty net premiums written in both the Americas and EMEA regions, it also improved the accident year loss ratio, as adjusted. Severe losses represented approximately 2.8 points in 2013 compared to 1.4 points in 2012, and are included in the accident year loss ratio, as adjusted. In 2013, one single event, totaling $131 million, accounted for approximately 0.6 points of the increase.
The acquisition ratio decreased by 0.5 points in 2013 compared to 2012, primarily due to a change in business mix and reinsurance structures.
Acquisition expenses decreased in 2014 compared to 2013, primarily as a result of the decrease in new insurance written related to the decline in mortgage originations.
Other business results include second-lien insurance, student loan insurance and non-domestic mortgage insurance operations.
First-lien pre-tax operating income increased in 2013 compared to 2012, primarily due to improved underwriting income as a result of a $157 million decrease in first-lien losses and loss adjustment expenses incurred reflecting lower newly reported delinquencies and higher cure rates and a $127 million increase in first-lien net premiums earned largely from growth in the book of business in 2013. This increase was partially offset by $46 million of unfavorable prior year development in 2013 compared to unfavorable prior year development of $17 million in 2012. The decline in first-lien losses and loss adjustment expenses incurred combined with the increase in earned premiums resulted in an improved combined ratio of 91.1 points in 2013 compared to 134.4 points in 2012.
The decline in domestic first-lien new insurance written to $42.0 billion in 2014 from $49.4 billion in 2013 was primarily due to the contraction in the mortgage originations market and an increase in competition.
New insurance written increased to $49.4 billion in 2013 from $37.3 billion in 2012 due to the increase in mortgage originations.
The following tables present the Mortgage Guaranty combined ratios based on GAAP data:
The combined ratio decreased by 28.3 points in 2013 compared to 2012. The decrease was driven primarily by a reduction in the loss ratio by 28.7 points in 2013 due to lower losses and loss adjustment expenses incurred.
The general operating expense ratio remained relatively unchanged in 2013 compared to 2012.
Net investment income for 2014 decreased compared to 2013, primarily due to lower net investment income from alternative investments and from the base portfolio. The 2014 decrease in alternative investment income of $41 million compared to 2013 primarily reflected high hedge fund income in 2013 due to favorable equity market conditions. The decrease in base net investment income in 2014 compared to 2013 primarily reflected lower base portfolio yield as a result of reinvestment in the
low interest rate environment, partially offset by growth in average assets. See MD&A - Investments - Life Insurance Companies for additional information on the investment strategy, asset-liability management process and invested assets of our Life Insurance Companies, which include the invested assets of the Institutional Markets business.
Pre-tax operating income for 2013 increased compared to 2012, due in part to higher net investment income from alternative investments, partially offset by lower base net investment income. Interest credited to policyholder account balances in 2012 included $110 million of expense resulting from a comprehensive review of reserves for the GIC portfolio. Results for 2013 included a full year of the growing stable value wrap business, which contributed $31 million to the increase in pre-tax operating income compared to 2012. Stable value wrap notional assets under management grew to $24.6 billion at December 31, 2013 from $10.4 billion at December 31, 2012, including the notional amount of contracts transferred from an AIG affiliate.
Net investment income for 2013 increased slightly compared to 2012, primarily due to higher net investment income from alternative investments, largely offset by lower income from the base portfolio. The increase in alternative investment income in 2013 compared to 2012 reflected higher hedge fund income due to favorable equity market conditions. The decrease in base net income was primarily due to investment of available cash, including proceeds from sales of securities made during 2013 to utilize capital loss carryforwards, at rates below the weighted average yield of the overall portfolio.
The increase in premiums in 2013 compared to 2012 reflected a high volume of single-premium product sales in 2013, including structured settlements with life contingencies and terminal funding annuities. The increase in deposits in 2013 compared to 2012 reflected strong sales of high net worth products, primarily private placement variable annuities.
* Includes general operating expenses, non deferrable commissions, other acquisition expenses, advisory fee expenses and other expenses.
Consumer Insurance presents its operating results in three operating segments - Retirement, Life and Personal Insurance. The following section provides a comparative discussion of Consumer Insurance Results of Operations for 2014, 2013 and 2012 by operating segment.
Base net investment income for 2014 increased slightly compared to 2013, as participation income on a commercial mortgage loan and income from the redemption of an invested asset in 2014 more than offset the effect of lower base yields from reinvestment at rates below the weighted average yield of the overall portfolio. See Investments - Life Insurance Companies for additional information on the investment strategy, asset-liability management process and invested assets of our Life Insurance Companies, which include the invested assets of the Retirement business.
General operating expenses increased in 2014 compared to 2013, due in part to technology investments and the volume of continued sales growth of annuities in the Retirement Income Solutions and Fixed Annuities product lines.
Pre-tax operating income for Retirement in 2013 increased significantly compared to 2012, reflecting higher fee income from variable annuities driven by growth in assets under management, active spread management in interest rate sensitive product lines, higher alternative investment income, and higher positive impact of actuarial assumption updates. Commissions and advisory fees reflected in Advisory fee and other income, and related Advisory fee expenses, were both higher in 2013 compared to 2012 principally due to the acquisition of Woodbury Financial Services Inc. (Woodbury Financial) in November 2012.
General operating expenses increased in 2013 compared to 2012 primarily to support stronger sales of annuities in the Retirement Income Solutions and Fixed Annuities product lines and increased Retail Mutual Fund sales. Higher operating expenses in 2013 also reflected the acquisition of Woodbury Financial in November 2012, and the absence of guaranty fund assessment credits received in 2012.
Disciplined pricing on new business and active crediting rate management have allowed the Retirement operating segment to maintain base investment spread rates in the Fixed Annuities and Group Retirement product lines for 2014 at a level comparable to 2013, during a period in which base yields continued to decline due to investment of available cash flows in the low interest rate environment, including the full year impact from reinvestment of proceeds from sales made during 2013 to utilize capital loss carryforwards. The base investment spread rates for the Fixed Annuities and Group Retirement product line improved in 2013 compared to 2012 as a result of our disciplined pricing and management of renewal crediting rates.
The following table presents fixed annuity account values by contractual minimum guaranteed interest rate and current crediting rates:
The following table presents a reconciliation of Retirement premiums and deposits to GAAP premiums:
Premiums increased in 2014 compared to 2013, and in 2013 compared to 2012, primarily due to higher immediate annuity premiums in the Fixed Annuities product line.
Total net flows for Retirement decreased in 2014 compared to 2013, as higher surrenders and withdrawals in 2014, primarily in the Group Retirement and Retail Mutual Fund product lines, resulted in a significant decrease in net flows compared to 2013. Net flows for Retirement increased in 2013 compared to 2012, primarily due to the increase in premiums and deposits, partially offset by higher surrenders in Group Retirement and Retail Mutual Funds. See below for additional discussion of each product line.
Fixed Annuities deposits increased in 2014 compared to 2013 due to modest increases in interest rates and steepening of the yield curve in the first half of 2014, compared to lower rates in the prior year, particularly in the first half of 2013. The increase in Fixed Annuities deposits in 2013 compared to 2012 was due to the increase in market interest rates in the second half of 2013. Fixed Annuities net flows continued to be negative, but improved slightly in 2014 compared to 2013, and improved significantly in 2013 compared to 2012, primarily due to the increased deposits.
Retirement Income Solutions premiums and deposits and net flows increased significantly in 2014 compared to 2013, and in 2013 compared to 2012, reflecting a continued high volume of variable and index annuity sales, which have benefitted from consumer demand for retirement products with guaranteed benefit features, product enhancements, expanded distribution and a more favorable competitive environment. The improvement in the surrender rate (see Surrender Rates below) was primarily due to the significant growth in account value driven by the high volume of sales, which has increased the proportion of business that is within the surrender charge period.
Group Retirement net flows decreased in 2014 compared to 2013, primarily due to higher group surrender activity, as well as lower premiums and deposits. The increase in surrenders and surrender rate for 2014 compared to 2013 included large group surrenders of approximately $2.7 billion, but reserves of this product line grew in 2014 compared to 2013, and the 2014 surrender activity is not expected to have a significant impact on pre-tax operating income in 2015. The large group market has become increasingly competitive and has been impacted by the consolidation of healthcare providers and other employers in our target markets. This trend of heightened competition is expected to continue in 2015 as plan sponsors perform reviews of existing retirement plan relationships. The decrease in Group Retirement net flows in 2013 compared to 2012 was primarily a result of higher surrenders of individual participants as well as large group surrenders.
Overall, mortality experience for 2014 was similar to 2013 and within pricing assumptions. Policyholder benefit expense in 2014 included an increase of approximately $104 million to the estimated reserves for IBNR death claims, which reflected continuing efforts to identify deceased insureds and their beneficiaries who have not presented a valid claim, pursuant to the 2012 resolution of a multi-state audit and market conduct examination. The 2014 increase in the IBNR reserve was related primarily to a legacy block of in-force and lapsed small face amount policies, for which the personal data elements to effect a match against the Social Security Death Master File are unavailable or incomplete, such as full legal name, date of birth or Social Security number. In 2014, in the process of reviewing these policies as required under the terms of the regulatory agreement, we have refined our estimate of the ultimate cost of these claims. The $104 million reserve increase in 2014 was in addition to amounts previously provided for IBNR claims in 2011 and 2012, which totaled $259 million. While we believe that we are adequately reserved for such claims, there can be no assurance that the ultimate cost will not vary from the current estimate.
Pre-tax operating income increased in 2013 compared to 2012, primarily due to additional expenses recorded in 2012, which included $67 million of loss recognition reserves for long-term care products, $57 million of additional IBNR claim reserves and an $11 million regulatory assessment related to the resolution of multi-state regulatory examinations of death claims practices, and an accrual of $20 million from consolidation of certain life operations and administrative systems. The increase in pre-tax operating income in 2013 due to the absence of these prior year expenses was partially offset by a $28 million increase in equity indexed universal life reserves in 2013, as well as a higher net negative adjustment of $80 million in 2013, compared to $43 million in 2012, to update certain gross profit assumptions used to amortize DAC and related items for universal life products.
The decrease in Life premiums in 2014 compared to 2013 was primarily due to the non-renewal of certain group benefit accounts and the strengthening of the U.S. dollar against the Japanese yen, partially offset by solid growth in Japan premiums excluding the effect of foreign exchange. The decrease in premiums for 2013 compared to 2012 was the result of the run-off of an older block of traditional life in the U.S. and the strengthening of the U.S. dollar against the Japanese yen, which exceeded the increase from new sales of traditional products.
Pre-tax operating income increased in 2014 compared to 2013, primarily due to a decrease in current accident year losses and lower general operating expenses, partially offset by higher catastrophe losses and lower net favorable prior year loss reserve development, higher acquisition expenses and a decrease in net investment income. Catastrophe losses were $126 million in 2014, compared to $77 million in 2013. The accident year losses include severe losses of approximately $54 million in 2014 compared to $17 million in 2013. Net favorable loss reserve development was $77 million in 2014 compared to $155 million in 2013, and included approximately $7 million of favorable loss reserve development from Storm Sandy compared to $41 million in 2013. Foreign exchange did not have a significant impact on the pre-tax operating income compared to 2013.
Acquisition expenses increased in 2014 compared to 2013, primarily due to the change in business mix and higher costs in growth-targeted lines of business, partially offset by the effect of foreign exchange as a result of the strengthening of the U.S. dollar against the Japanese yen. Direct marketing expenses, excluding commissions, for 2014 were $392 million, compared to
See MD&A - Investments for additional information on the Non-Life Insurance Companies invested assets, investment strategy, and asset-liability management process.
Pre-tax operating income increased in 2013 compared to 2012, primarily due to a lower underwriting loss, partially offset by a decrease in net investment income. Underwriting results improved primarily due to lower catastrophe losses and higher net favorable loss reserve development, coupled with lower acquisition expenses. Catastrophe losses in 2013 were $77 million, compared to $382 million in 2012. Net favorable loss reserve development was $155 million in 2013, compared to $20 million in 2012. Additionally, 2013 included approximately $41 million of favorable loss reserve development from Storm Sandy. Foreign exchange did not have a significant impact on pre-tax operating income compared to 2012.
Acquisition expenses decreased in 2013 compared to 2012, primarily due to the change in business mix, partially offset by increased costs in growth-targeted lines of business. Direct marketing expenses, excluding commissions, for 2013 were $440 million, compared to $452 million in 2012. Excluding the effect of foreign exchange, direct marketing expenses increased by approximately $46 million in 2013 compared to 2012.
General operating expenses decreased slightly in 2013 compared to 2012, primarily due to reduced costs of strategic initiatives, technology-related and infrastructure expenses. These were largely offset by the increase in employee incentive plan expenses, which reflected the alignment of employee performance with the overall performance of the organization, including our stock performance, and accelerated vesting provisions for retirement-eligible individuals in the 2013 share-based plan, as well as the strategic expansion into growth economy nations.
Net investment income decreased in 2013 compared to 2012, primarily due to a change in allocated investment income as a result of lower net loss reserves from a change in the business mix.
The following table presents Personal Insurance net premiums written by major line of business:
Personal Insurance net premiums written decreased in 2014, compared to 2013, primarily due to the impact of foreign exchange as the U.S. dollar strengthened against the Japanese yen. Excluding the effect of foreign exchange, net premiums written increased in 2014 compared to 2013 as the business continued to grow through multiple product and distribution channels, including direct marketing.
Personal Lines net premiums written, excluding the effect of foreign exchange, increased in 2014 compared to 2013. The increase was primarily due to increased rates and improved retention in AIG Private Client Group and continued growth of automobile business outside of Japan, partially offset by declines in the U.S. warranty service programs.
Personal Insurance net premiums written decreased in 2013, compared to 2012, primarily due to the impact of foreign exchange as the U.S. dollar strengthened against the Japanese yen. Excluding the impact of foreign exchange, net premiums written increased in 2013 compared to 2012 as the business continued to build momentum through multiple distribution channels.
The following table presents Personal Insurance net premiums written by region:
Asia Pacific net premiums written decreased in 2014 compared to 2013, primarily due to the strengthening of the U.S. dollar against the Japanese yen. Excluding the effect of foreign exchange, net premiums written increased, primarily due to production increases in Japan A&H and in property and automobile business outside of Japan.
EMEA net premiums written increased in 2014 compared to 2013, due to growth in the automobile business and warranty service programs, partially offset by a decrease in the A&H business.
* 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.
The combined ratio decreased by 1.6 points in 2014 compared to 2013, primarily due to a lower loss ratio, partially offset by a higher acquisition ratio as discussed below.
The accident year loss ratio, as adjusted, increased by 0.9 points in 2013 compared to 2012, primarily due to the effect of higher losses associated with a warranty retail program, group accident, and travel business in the U.S. and Canada, which in the aggregate increased the loss ratio by 1.7 points. This was partially offset by improvements in automobile and personal property, as a result of rate and underwriting actions taken in 2013 and prior years. The higher losses associated with the warranty retail program were largely offset by a decrease in the related profit sharing arrangement reflected in acquisition costs.
The acquisition ratio increased by 0.9 points in 2013 compared to 2012, primarily due to the combined effect of lower net premiums earned base, change in business mix and higher costs in growth-targeted lines of business. This was partially offset by a decrease in a profit sharing arrangement associated with the warranty retail program noted above.
(a) Includes $263 million of severance expense attributable to Property Casualty and Personal Insurance operating segments.
(b) Represents our share of AerCap’s pre-tax operating income, which excludes certain post-acquisition transaction expenses incurred by AerCap in connection with its acquisition of ILFC and the difference between expensing AerCap’s maintenance rights assets over the remaining lease term as compared to the remaining economic life of the related aircraft.
(c) During 2014, the Life Insurance Companies sold their investment in PICC Group to AIG Parent.
DIB pre-tax operating income decreased in 2014 compared to 2013 primarily due to lower fair value appreciation on asset-backed security (ABS) collateralized debt obligations (CDOs) and declines in net credit valuation adjustments on assets and liabilities for which the fair value option was elected, partially offset by lower interest expense on borrowings resulting from redemptions and repurchases of DIB debt in 2014.
Fair value appreciation on ABS CDOs was $789 million and $954 million in 2014 and 2013, respectively. The fair value appreciation on the ABS CDOs was higher in 2013, driven primarily by improved collateral pricing due to more significant improvements in home price indices and amortization of the underlying collateral.
DIB pre-tax operating income increased in 2013 compared to 2012 primarily due to fair value appreciation on ABS CDOs that were acquired in the fourth quarter of 2012, partially offset by a decline in net credit valuation adjustments on assets and liabilities for which the fair value option was elected.
GCM’s pre-tax operating income decreased in 2014 compared to 2013 primarily due to declines in unrealized market valuation gains related to the super senior credit default swap (CDS) portfolio and declines in net credit valuation adjustments on derivative assets and liabilities, partially offset by gains realized upon unwinding certain positions and a decrease in operating expenses. As previously disclosed in prior quarters, a state regulatory agency has requested additional information relating to the unwinding of a position on which we realized gains of $196 million in 2014.
Net credit valuation adjustment losses of $98 million were recognized in 2014 compared to net credit valuation adjustment gains of $195 million in the prior year. The decline resulted primarily from the recognition of credit valuation losses on derivative assets in 2014 due to higher exposure of uncollateralized derivative assets compared to credit valuation gains on uncollateralized derivative assets in the prior year due to the tightening of counterparty credit spreads.
Run-off insurance lines reported pre-tax operating income of $403 million in 2013 compared to a loss of $135 million in 2012, primarily as a result of a $631 million benefit in reserve discount compared to a $37 million charge in 2012, partially offset by a $98 million increase in net adverse prior year loss reserve development. The discount benefit was primarily due the use of permitted practices from state regulators to use payout patterns specific to the excess workers compensation reserves and a discount rate based on the forward U.S Treasury curve plus a liquidity premium (as opposed to the previously prescribed discount factors.
Other businesses’ pre-tax operating income improved in 2014 compared to 2013 due to an increase in gains on investments in life settlements resulting from higher net death benefits.
Other businesses’ pre-tax operating loss in 2013 was essentially flat compared to 2012.
General operating expenses increased in 2013 compared to 2012 due to higher incentive compensation costs. In addition, 2012 included reductions in expenses of $211 million resulting from the decrease in the estimate of the liability for the Department of the Treasury’s underwriting fees in connection with sales of AIG Common Stock.
We sold our remaining 33 percent interest in AIA ordinary shares for proceeds of $14.5 billion and a net gain of $2.1 billion through three sale transactions on March 7, September 11, and December 20, 2012.
• While more of a focus is placed on asset-liability matching in Life Insurance Companies, our fundamental strategy across all of our investment portfolios is to match the duration characteristics of the liabilities with assets of comparable duration, to the extent practicable.
grade rated fixed maturity securities. Based upon an assessment of its immediate and longer-term funding needs, AIG Parent purchases publicly traded, intermediate term, investment-grade rated fixed maturity securities that can be readily monetized through sales or repurchase agreements. These securities allow us to diversify sources of liquidity while reducing the cost of maintaining sufficient liquidity.
The following tables summarize the composition of AIG's investments by legal entity:
For the Non-Life 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 Non-Life Insurance Companies focuses on growth of surplus and preservation of capital, subject to liability and other business considerations.
The Non-Life 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 Non-Life 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 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 Non-Life Insurance Companies’ liquidity, duration and credit quality objectives as well as current risk-return and tax objectives.
Fixed maturity investments of the Non-Life Insurance Companies domestic operations, with an average duration of 4.3 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 monitor fixed income markets, including the level of interest rates, credit spreads and the shape of the yield curve. The Life Insurance Companies frequently review their interest rate assumptions and actively manages the crediting rates used for their new and in-force business. Business strategies continue to evolve to maintain profitability of the overall business in a historically low interest rate environment. The low interest rate environment makes it more difficult to profitably price attractive guaranteed return products and puts margin pressure on existing products, due to the challenge of investing recurring premiums and deposits and reinvesting investment portfolio cash flows in the low rate environment while maintaining satisfactory investment quality and liquidity. In addition, there is investment risk associated with future premium receipts from certain in-force business. Specifically, the investment of these future premium receipts may be at a yield below that required to meet future policy liabilities.
Fixed maturity investments of the Life Insurance Companies domestic operations, with an average duration of 6.62 years, are comprised of taxable corporate bonds, as well as taxable municipal and government bonds, and agency and non-agency structured securities. The majority of these investments are held in the available for sale portfolio and are rated investment grade based on its composite ratings.
Fixed maturity investments held in the Life Insurance Companies foreign operations are of high quality, primarily rated A or higher based on composite ratings, and intermediate duration, averaging 12.68 years.
The Securities Valuation Office (SVO) of the NAIC evaluates the investments of U.S. insurers for statutory reporting purposes and assigns fixed maturity securities to one of six categories called ‘NAIC Designations.’ In general, NAIC Designations of ‘1’ highest quality, or ‘2’ high quality, include fixed maturity securities considered investment grade, while NAIC Designations of ‘3’ through ‘6’ generally include fixed maturity securities referred to as below investment grade. The NAIC has adopted revised rating methodologies for certain structured securities, including non-agency RMBS and CMBS, which are intended to enable a more precise assessment of the value of such structured securities and increase the accuracy in assessing expected losses to better determine the appropriate capital requirement for such structured securities. These methodologies result in an improved NAIC Designation for such securities compared to the rating typically assigned by the three major rating agencies. The following tables summarize the ratings distribution of Life Insurance Companies fixed maturity security portfolio by NAIC Designation, and the distribution by composite AIG credit rating, which is generally based on ratings of the three major rating agencies. See Investments - Credit Ratings herein for a full description of the composite AIG credit ratings.
The following table presents the fixed maturity security portfolio of Life Insurance Companies categorized by NAIC Designation, at fair value:
At December 31, 2014, approximately 90 percent of our fixed maturity securities were held by our domestic entities. Approximately 17 percent of such 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.
A significant portion of our foreign entities’ fixed maturity securities portfolio is rated by Moody’s Investors’ Service Inc. (Moody’s), Standard & Poor’s Financial Services LLC, a subsidiary of The McGraw-Hill Companies, Inc. (S&P), or similar foreign rating services. Rating services are not available for some foreign-issued securities. Our Credit Risk Management department closely reviews the credit quality of the foreign portfolio’s non-rated fixed maturity securities. At December 31, 2014, approximately 17 percent of such investments were either rated AAA or, on the basis of our internal analysis, were equivalent from a credit standpoint to securities rated AAA, and approximately five percent were below investment grade or not rated. Approximately 44 percent of the foreign entities’ fixed maturity securities portfolio is comprised of sovereign fixed maturity securities supporting policy liabilities in the country of issuance.
(a) Excludes certain university and not-for-profit entities that issue their bonds in the corporate debt market. Includes industrial revenue bonds.
(a) Includes certain RMBS that had experienced deterioration in credit quality since their origination. See Note 6, Investments - Purchased Credit Impaired (PCI) Securities to the Consolidated Financial Statements for additional discussion.
Our underwriting practices for investing in RMBS, other asset-backed securities and CDOs take into consideration the quality of the originator, the manager, the servicer, security credit ratings, underlying characteristics of the mortgages, borrower characteristics, and the level of credit enhancement in the transaction.
See Note 7, Lending Activities, to the Consolidated Financial Statements for further discussion.
There was no significant impact to our consolidated financial condition or results of operations from other-than-temporary impairment charges for any one single credit. Also, no individual other-than-temporary impairment charge exceeded 0.01, 0.02 percent and 0.11 percent of total equity at December 31, 2014, 2013 and 2012, respectively.
(b) Represents the percentage by which fair value is less than cost at December 31, 2014.
The change in net unrealized gains and losses on investments in 2014 was primarily attributable to increases in the fair value of fixed maturity securities. For 2014, net unrealized gains related to fixed maturity and equity securities increased by $7.3 billion due to a decrease in interest rates on investment grade fixed maturity securities, partially offset by the widening of spreads.
The change in net unrealized gains and losses on investments in 2013 were primarily attributable to decreases in the fair value of bonds available for sale. Net unrealized gains related to fixed maturity and equity securities decreased by $13.7 billion primarily due to the increase in U.S. Treasury rates, partially offset by the narrowing of credit spreads and the realization of approximately $2.5 billion in gains from sales of securities.
See also Note 6, Investments to the Consolidated Financial Statements for further discussion of our investment portfolio.
The following section provides discussion of insurance reserves for both the Non-Life Insurance Companies and the Life Insurance Companies.
The following section provides discussion of the consolidated liability for unpaid losses and loss adjustment expenses for the Non-Life Insurance Companies.
On January 1, 2014, the Non-Life Insurance Companies merged their two internal pooling arrangements into one pool, and changed the participation percentages of the pool members, resulting in a reallocation of 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, the Non-Life Insurance Companies recognized a discount benefit of $110 million in the first quarter of 2014.
The following table summarizes development, (favorable) or unfavorable, of incurred losses and loss expenses for prior years, net of reinsurance, by business unit and major class of business:
In determining the loss development from prior accident years, AIG analyzes and evaluates the change in estimated ultimate loss for each accident year by class of business. For example, if loss emergence for a class of business is different than expected for certain accident years, we examine the indicated effect such emergence would have on the reserves of that class of business. In some cases, the higher or lower than expected emergence may result in no clear change in the ultimate loss estimate for the accident years in question, and no adjustment would be made to the reserves for the class of business for prior accident years. In other cases, the higher or lower than expected emergence may result in a large change, either favorable or unfavorable. As appropriate, we make adjustments for the difference between the actual and expected loss emergence for each accident year. As part of our reserving process, we also consider notices of claims received with respect to emerging and/or evolving issues.
In 2014, the adverse prior year loss reserve development, including premium adjustments of $105 million, was $598 million, which was driven by reserve increases on claims in Commercial Insurance and Other - U.S. The net adverse prior year loss reserve development in Commercial Insurance was driven by Primary Casualty, Environmental, International Financial Lines and Healthcare, partially offset by Natural catastrophes, International Primary Casualty and International Commercial Property, while the adverse development in Other - U.S. was driven by adverse development on legacy asbestos and pollution exposures (1986 and prior) and run-off environmental exposures (1987 - 2004). The U.S. Primary Casualty adverse prior year loss reserve development of $445 million was driven by primary General Liability ($182 million), primary Auto Liability ($156 million) and primary Workers’ Compensation ($137 million) due to worse than expected emergence and updated loss development and expected loss ratio assumptions.
For the year ended December 31, 2014, we incurred reinsurance reinstatement premiums of ($2) million, compared to $27 million for 2013 and $0 for 2012.
We maintain an active environmental insurance business related to pollution legal liability and general liability for environmental consultants and engineers, as well as run-off business for certain environmental coverage which provides cost overrun protection, in some cases over long time periods. We evaluate and report reserves associated with this business separately from the 1986 and prior asbestos and environmental reserves associated with standard General Liability and Umbrella policies discussed under “Asbestos and Environmental Reserves”.
Historically, we had used traditional actuarial methods to assess the reserves for pollution products. The comprehensive claims review process that began in 2012 provided a more refined approach for the development of actuarial estimates for toxic tort claims (which were found to have a distinctly lengthier loss development pattern than other general liability claims in the environmental portfolio) as well as a more appropriate methodology for incorporating case reserving based estimates of ultimate loss costs for complex claims involving environmental remediation and/or from policies with high policy limits (greater than $5 million per policy). Notwithstanding the refined methodology and approach applied in 2012 and subsequently, considerable uncertainty remains over the ultimate loss costs for this class of business, especially for business written in accident years 2003 and prior.
Because of an increase in the frequency and severity of claims observed beginning in 2011, the 2012 loss reserve review consisted of an intensive review of reported claims by a multi-disciplinary team including external specialists in environmental law and engineering science, toxicologists and other specialists, our actuaries, claims managers and underwriters to reassess our indicated loss reserve need. The review improved our understanding of factors that drive claim costs such as policy term, limit, pollution conditions covered, location of incident and applicable laws and remediation standards. The analysis used these factors to segment and analyze the claim data to determine ultimate costs, in some cases, on a claim by claim basis. As a result of this analysis, $200 million of adverse prior year loss reserve development was recognized during 2012, including $166 million for pollution products reported in the run-off unit. The majority (81 percent) of the adverse development related to accident years 2003 and prior, before significant underwriting changes were adopted.
In addition to reserving actions, we have made significant changes to the ongoing environmental business included in Commercial Insurance with the goal of ensuring that the current policies are being written to earn an appropriate risk adjusted profit. Underwriting guidelines have been revised to no longer cover known or expected clean up costs, which were a significant driver of historical claims, and a “new emerging contaminants” team has been formed within the dedicated environmental engineering staff to track any new cleanup standards that may be set by federal or state regulators. Further, engineering reviews are required for specific business segments (such as oil and gas, and landfills) that have traditionally generated higher losses.
Primary Casualty includes Workers’ Compensation, General Liability and Auto Liability lines of business. In addition, these lines of business are categorized into classes of business including National Accounts, Commercial Risk, Specialty Workers’ Compensation, Energy, Multi National, Construction, Transportation and Trucking.
The National Accounts class of business includes casualty insurance for businesses with revenues of $700 million or more. The Commercial Risk class of business includes casualty insurance for businesses with revenues of less than $700 million. The majority of the business is workers’ compensation. The Specialty Workers’ Compensation class of business includes small monoline guaranteed cost risks. Our Specialty Workers’ Compensation class of business grew significantly in the early to mid 2000s but has reduced premium writings by nearly 70 percent since 2007. The Energy class of business includes casualty insurance (including workers’ compensation) in the mining, oil and gas and power generation sectors. The Construction, Transportation and Trucking class of business includes casualty insurance (including workers’ compensation) within that industry.
During 2014, we continued to refine our segmentation of primary workers’ compensation into guaranteed cost and excess of large deductible business by deductible size group. The net result of the analysis was adverse development of $137 million for the primary workers’ compensation class of business. The key drivers of the adverse development in this class of business were increases for guaranteed cost business in California and New York, and increases for excess of large deductible business, as well as adverse experience in the Construction class. Each of these segments appears to have been impacted by specific structural changes in the portfolio. For California business, our tail factor increases were in response to changing long-term medical development patterns. In New York, there has been a lengthening of the period between the date of accident and the classification of non-scheduled permanent partial injuries. We completed a review of claim emergence and payouts for our top six states in workers’ compensation and concluded that California and New York were the main states where the loss development patterns had materially changed since our last review. For excess of large deductible business across all states, we updated our analyses to consider the impact of changes in the mix of retentions that has occurred over time as the data by retention band was becoming more credible. For the Construction class, we note that the construction sector has experienced a comparatively slow recovery in payroll employment. As a result of the diminished employment opportunities in this industry sector, injured workers may experience limited return-to-work opportunities, which moderate the shortening of claim duration that normally accompanies a labor market recovery. For all other states combined excluding California and New York, we saw favorable emergence in our middle market Specialty Workers’ Compensation segment. The net effect of these revised selections had the greatest adverse effect on the Construction class of business ($140 million adverse development) and the National Accounts class of business ($125 million adverse development). The most significant favorable effect was in the Specialty Workers’ Compensation class of business ($155 million favorable development). Our analysis considers our best estimate expectations of medical inflation and loss costs trends and also reflects the impacts of enhancements in our claim management and loss mitigation activities, such as opioid management, fraud investigation and medical management.
For commercial auto 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 for the automobile subset of primary casualty.
During 2013, for primary general liability, we increased our reserves for prior years by approximately $355 million. Most of the increase was driven by construction-related primary general liability claims, especially construction defect claims where we increased our ultimate loss estimates by $219 million to reflect the higher than expected frequency and severity of these claims especially in states that experienced heavy increases in construction activity after the 2004 and 2005 hurricanes and during the housing boom prior to 2007. Due to the subsequent home price declines observed in many of these states, the frequency of reported losses has increased as the losses subsequently represented a larger percentage of the equity values of the affected homes, and homeowners increasingly looked to insurance recoveries as a way to recoup some of that lost value.
During 2012, we significantly intensified our claims management efforts for those primary workers’ compensation claims which are managed by AIG. These efforts include consulting with various specialists, including clinical and public health professionals and other advisors. We also continued to refine our actuarial methodologies for estimating ultimate loss costs incorporating a more refined segmentation by state (California and New York were analyzed separately) and a more refined approach for business subject to deductibles as well as business subject to premium adjustments (loss-sensitive business). Based on these enhanced reviews, we increased reserves by $46 million.
During 2014, we recognized $109 million of adverse development in this class 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.
Our Global Financial Lines Claims unit has implemented its target operating model in Europe and Australasia 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 reserve studies. The actuaries see evidence of earlier settlement of claims on a paid and incurred basis in the International Financial Lines class of business. During 2014, we recognized $182 million of adverse development in the international Financial Lines segments, driven by large claims emergence in the U.K., Australasia and Europe. Multiple accident years contributed to this total, but it was concentrated most heavily in accident years 2008-2011. The Australasia emergence was due to a number of specific large losses in the Australia and New Zealand D&O business. In Europe, adverse prior year loss reserve development was concentrated in the D&O class of business, where we have observed a greater incidence of severe claims compared with prior years, and the Professional class of business, with large losses from one insured. The new business written across International Financial Lines continues to meet risk adjusted profitability targets after the increased estimates of ultimate losses for the more recent accident years.
During 2013, we recognized $74 million of adverse development, all of which stemmed from losses in the D&O books in Europe, UK and Australasia, with the other segments showing modest favorable development. The development we recognized can be directly linked to a small number of specific claims booked throughout the year.
During 2012, we recognized $33 million of adverse development, concentrated in Europe and Australasia D&O, which was related to a small number of specific severe claims in those regions.
This class of business, which is reported in our run-off unit, has an extremely long tail and is one of the most challenging classes of business to reserve for, particularly when the excess coverage is provided above a self-insured retention layer. The class is highly sensitive to small changes in assumptions - in the rate of medical inflation or the longevity of injured workers, for example - which can have a significant effect on the ultimate reserve estimate.
During 2014, we updated our analyses of Excess Workers compensation using a range of scenarios and methodologies and determined that our carried reserves were adequate after recognizing $20 million of favorable prior year development as a result of claim settlements and commutations of 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 our proactive management by the run-off unit. The reduction in nominal reserves as a result of assumed reinsurance commutations and individual claims settlement strategies amounted to $242 million in 2014, compared to $25 million in 2013. The results from these strategies also impacted the loss payout patterns used in our discount calculations, previously discussed.
During the 2012 loss reserve review, we augmented traditional reserve methodologies with an analysis of underlying claims cost drivers to inform our judgment of the ultimate loss costs for open reported claims from accident years 2003 and prior
(representing approximately 95 percent of all open reported claims) and used the refined analysis to inform our judgment of the ultimate loss cost for claims that have not yet been reported using a frequency/severity approach for these accident years.
This approach was deemed to be most suitable for injured workers whose medical conditions had largely stabilized (i.e., at least 9 to 10 years have elapsed since the date of injury). The reserves for accident years 2004 and subsequent (13 percent of total case and IBNR reserves for this class) were determined using traditional methods.
During 2013, we experienced adverse development from Storm Sandy totaling $108 million, or 5.4 percent of the 2012 estimate. This development resulted from higher severities on a small number of large and complex commercial claims driven by a number of factors including the extensive damage caused to properties in the downtown New York metropolitan area.
Mortgage Guaranty business includes domestic first liens (93 percent of total reserves) and small run-off books in second liens, student loans and international.
During 2014, we recognized $104 million of favorable prior year loss reserve development driven in part by steady increases in year-over-year first lien cure rates, a reflection of the improved economic environment, and in part by favorable frequency trends and recoveries in second lien claims. Partially offsetting these improvements were upward trends in severity, particularly for older (pre-2012) accident periods.
During 2013, we recognized $30 million of adverse prior year loss reserve development due to unfavorable emergence of overturns of prior claim cancellations and increased severity estimates in first liens, partially offset by favorable frequency in student loans and a reduction in the unallocated loss adjustment expense reserve.
During 2012, we recognized $78 million of favorable prior year loss reserve development due to higher than expected cancellation rates on first lien legacy claims, combined with improving frequency trends and strong recoveries in second lien claims.
See Item 7. MD&A - Critical Accounting Estimates - Liability for Unpaid Losses and Loss Adjustment Expenses for further discussion of our loss reserving process.
See Commercial Insurance and Consumer Personal Insurance Results herein for further discussion of net loss development.
For 2012, the favorable development from accident year 2011 was driven primarily by the favorable development on natural catastrophes, primarily the Tohoku Catastrophe, and the adverse development from accident years 2003 and prior was primarily the result of the increase in reserves on runoff pollution product business (policies written between 1987 and 2003).
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 AIG. These reclassifications are shown as development in the respective years in the tables above.
(b) Loss sensitive business that is offset by premium adjustments and has no income statement impact. Approximated based on prior accident year development recognized from policy year premium charges.
(d) Includes results of comprehensive specific large claim file reviews initiated in 2012 and updated in 2013 and 2014.
The main sources of unfavorable prior year development for accident years 2004 and prior, representing 95 percent of the total recorded in 2012 through 2014, are as follows:
• Loss sensitive business that is entirely offset by premium adjustments accounted for $96 million;
• Update of the loss development patterns used for U.S. Primary Casualty including loss development patterns used in guaranteed cost workers’ compensation in CA and NY, the construction class of business and updates to the loss development patterns for business written on excess of deductible exposures in workers’ compensation, general liability and the commercial auto classes of business which collectively accounted for approximately $577 million across the three years;
• Update of our net retained asbestos and environmental exposure from 1986 and prior which accounted for approximately $266 million ($196 million environmental and $70 million asbestos) across the three years; and
• Commutations in the three-year period ending December 31, 2014, accounted for approximately $162 million. These commutations serve to reduce the uncertainty in AIG’s required reserves.
We consider a number of factors and recent experience, in addition to the results of both external and internal analyses, to estimate asbestos and environmental loss reserves. Nonetheless, we believe that significant uncertainty remains as to our ultimate liability for asbestos and environmental claims, which is due to several factors, including:
(a) Re-estimation of amounts recoverable under retroactive reinsurance contracts includes effect of changes in reserve estimates and changes in discount.
On June 17, 2011, we completed a transaction under which the bulk of AIG Property Casualty’s net domestic asbestos liabilities were transferred to National Indemnity Company (NICO), a subsidiary of Berkshire Hathaway, Inc. This was part of our ongoing strategy to reduce our overall loss reserve development risk. This transaction covers potentially volatile U.S.-
Under retroactive reinsurance arrangements any recoveries for development associated with the ceded losses are not recognized immediately; rather this development increases or decreases the deferred gain, and is amortized into income as described above. During 2013, we recognized approximately $86 million of adverse loss development that was ceded under this reinsurance arrangement, which was partially offset by $15 million of deferred gain amortization. This development, net of the deferred gain amortization, is being reported in Other income/expense, consistent with the way we manage the business and assess performance and is therefore excluded from net losses incurred and our loss ratios to avoid distortion related to our ongoing insurance business.
(a) The number of environmental claims dismissed or otherwise resolved, increased substantially during 2012 as a result of Non-Life Insurance Companies determination that certain methyl tertiary-butyl ether (MTBE) claims presented no further potential for exposure since these underlying claims were resolved through dismissal, settlement, or trial for all of the accounts involved. All of these accounts were fully reserved at the account level and included adequate reserves for those underlying individual claims that contributed to the actual losses. These individual claim closings, therefore, had no impact on Non-Life Insurance Companies environmental reserves.
(b) Represents an administrative change to the method of determining the number of open claims, which had no effect on carried reserves.
The following table presents AIG’s survival ratios for asbestos and environmental claims at December 31, 2014, 2013 and 2012. The survival ratio is derived by dividing the current carried loss reserve by the average payments for the three most recent calendar years for these claims. Therefore, the survival ratio is a simplistic measure estimating the number of years it would take before the current ending loss reserves for these claims would be paid off using recent year average payments.
The following table presents survival ratios for asbestos and environmental claims, separately and combined, which were based upon a three-year average payment:
The following section provides discussion of deferred policy acquisition costs and insurance reserves for Life Insurance Companies.
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 product line:
* Excludes loss recognition expense that was attributable primarily to investment sales related to capital loss carryforward utilization, which was excluded from pre-tax operating income and reported within changes in benefit reserves and DAC, VOBA and SIA related to net realized capital gains (losses).
Policy acquisition costs and policy issuance costs that are incremental and directly related to the successful acquisition of new or renewal of existing contracts for investment-oriented products are 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. Estimated gross profits include net investment income and spreads, net realized capital gains and losses, fees, surrender charges, expenses, and mortality gains and losses. If the assumptions used for estimated gross profits change significantly, DAC and related reserves (which may include VOBA, SIA, guaranteed benefit reserves and URR) are recalculated using the new assumptions, and any resulting adjustment is included in income. Updating such assumptions may result in acceleration of amortization in some products and deceleration of amortization in other products.
A net positive adjustment in the Retirement Income Solutions product line in 2014 was primarily due to improved mortality assumptions. Additional adjustments in the Retirement Income Solutions product line, related to assumptions used to value reserves and DAC for GMWB features that are accounted for as embedded derivatives and measured at fair value, were recorded in net realized capital gains (losses). Adjustments reported in net realized capital gains (losses), and in change in DAC related to net realized capital gains (losses), are included in the table of adjustments by reported line item below, and are not reflected in pre-tax operating income.
A net positive adjustment in the Group Retirement product line in 2014 was primarily due to more favorable assumptions for investment spreads and surrender rates than previously assumed.
A net negative adjustment in the Life product line in 2014 was due to lower investment spread and higher mortality assumptions than previously assumed. The updated mortality assumptions are still within pricing assumptions.
The net adjustments to DAC amortization from the unlocking of actuarial assumptions for estimated gross profits, including change in DAC related to net realized capital gains (losses), represented two percent and one percent of the DAC balance excluding the amount related to unrealized depreciation (appreciation) of investments as of December 31, 2014 and 2013, respectively.
The increases in net realized capital gains (losses) in 2014 and 2013, which were partially offset by adjustments to change in DAC related to net realized capital gains (losses), reflected updated mortality assumptions for GMWB embedded derivative liabilities in Retirement Income Solutions.
The following table presents a rollforward of Life Insurance Companies’ insurance reserves, including separate accounts and mutual fund assets under management, by operating segment:
Life Insurance Companies insurance reserves including separate accounts and mutual fund assets under management were comprised of the following balances:
Other reserve changes in the table above include loss recognition expense. Reserves related to unrealized appreciation of investments include shadow loss reserves. Loss recognition expense attributable primarily to investment sales related to capital loss carryforward utilization was excluded from pre-tax operating income and reported within changes in benefit reserves and DAC, VOBA and SIA related to net realized capital gains (losses) in Results of Operations - Consumer Insurance. See Critical Accounting Estimates - Future Policy Benefits for Life and Accident and Health Insurance Contracts for additional discussion of loss recognition.
Sales of investment securities in connection with the program to utilize capital loss carryforwards and other investment sales with subsequent reinvestment at lower yields triggered loss recognition expense, primarily on certain long-term payout annuity contracts in the Institutional Markets and Retirement segments, of $30 million in 2014, $1.5 billion in 2013 and $1.2 billion in 2012, which was not reflected in pre-tax operating income.
Shadow loss reserves of the Life Insurance Companies were not significant at December 31, 2013 and increased to $1.2 billion at December 31, 2014 primarily due to the increase in unrealized appreciation of investments during the year.
(a) In January 2015, we received $2.2 billion in additional dividends in the form of cash and fixed maturity securities from our Life Insurance Companies and, in February 2015, we received $600 million in additional cash dividends from our Non-Life Insurance Companies. These dividends had been declared during the three-month period ended December 31, 2014.
Interest payments totaled $3.4 billion in 2014, compared to $3.9 billion in 2013 and $4.0 billion in 2012. Excluding interest payments, AIG generated positive operating cash flow of $8.3 billion, $9.7 billion and $7.7 billion in 2014, 2013 and 2012, respectively.
Cash provided by operating activities of our Non-Life Insurance Companies was $0.9 billion in 2014 compared to $0.4 billion in 2013 and $1.1 billion in 2012, primarily reflecting the timing of the payments related to catastrophe losses in each year.
Cash provided by operating activities of our Life Insurance Companies was $4.4 billion in 2014, $4.3 billion in 2013 and $2.9 billion in 2012. The increase in 2013 compared to 2012 was primarily due to higher pre-tax operating income and higher proceeds from legal settlements with financial institutions that participated in the creation, offering and sale of RMBS from which our Life Insurance Companies realized losses during the financial crisis.
Cash provided by operating activities of businesses held for sale was $2.9 billion for each of 2013 and 2012.
Net cash provided by investing activities for 2013 included an increase in net investment purchase activity.
• payments of approximately $8.5 billion received in connection with the dispositions of ML III assets by the FRBNY; and
• gross proceeds of approximately $14.5 billion from the sale of AIA ordinary shares.
• approximately $294 million in the aggregate to pay dividends of $0.10 per share on AIG Common Stock in each of the third and fourth quarters of 2013;
• approximately $4.9 billion in repayments of long term debt of business held-for-sale.
• total payments of approximately $13.0 billion for the purchase of shares of AIG Common Stock.
As of December 31, 2014, AIG Parent had approximately $14.3 billion in liquidity sources. AIG Parent’s liquidity sources are held in the form of cash, short-term investments and publicly traded, intermediate-term investment grade rated fixed maturity securities. Fixed maturity securities consist of U.S. government and government sponsored entity securities, U.S. agency mortgage-backed securities, and corporate and municipal bonds. AIG Parent actively manages its assets and liabilities in terms of products, counterparties and duration. Based upon an assessment of its immediate and longer-term funding needs, AIG Parent purchases publicly traded, intermediate-term investment grade rated fixed maturity securities that can be readily monetized through sales or repurchase agreements. These securities allow us to diversify sources of liquidity while reducing the cost of maintaining sufficient liquidity. AIG Parent liquidity sources are 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, as well as credit and contingent liquidity facilities. AIG Parent’s primary uses of liquidity are for debt service, capital and liability management, operating expenses and subsidiary capital needs.
We believe that we have sufficient liquidity and capital resources to satisfy our reasonably foreseeable future requirements and meet our obligations to our creditors, debt-holders and insurance company subsidiaries. We expect to access the debt markets from time to time to meet funding requirements as needed.
In the normal course, it is expected that a portion of the capital released by our core insurance operations or through the utilization of AIG’s deferred tax assets may be available for distribution to shareholders. Additionally, it is expected that capital associated with businesses or investments that do not directly support our core insurance operations may be available for distribution to shareholders or deployment towards liability management upon its monetization.
In developing plans to distribute capital, AIG considers a number of factors, including, but not limited to: the capital resources available to support our core 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, as well as regulatory standards for capital and capital distributions.
(c) Unencumbered securities consist of publicly traded, intermediate-term investment grade rated fixed maturity securities. Fixed maturity securities consist of U.S. government and government sponsored entity securities, U.S. agency mortgage-backed securities, and corporate and municipal bonds.
AIG Parent and Ascot Corporate Name Limited (ACNL), a Non-Life Insurance Company, are parties to a $625 million letter of credit facility. ACNL, as a member of the Lloyd’s of London insurance syndicate (Lloyd’s), is required to hold capital at Lloyd’s, known as Funds at Lloyds (FAL). The entire FAL capital requirement of $625 million as of December 31, 2014, which supports the 2014 and 2015 years of account, was satisfied with a letter of credit issued under the facility.
We expect that our Life Insurance Companies will be able to continue to satisfy reasonably foreseeable future liquidity requirements and meet their obligations, including those arising from reasonably foreseeable contingencies or events, through cash from operations and, to the extent necessary, monetization of invested assets. Our Life Insurance Companies liquidity resources are held in the form of cash, short-term investments and publicly traded, investment grade rated fixed maturity securities.
Certain of our domestic 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 domestic 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. There were no outstanding securities lent under these programs by our domestic Life Insurance Companies as of December 31, 2014. The liability of our Life Insurance Companies to borrowers for collateral received was zero as of December 31, 2014 and $4.0 billion as of December 31, 2013.
AIG generally manages capital between AIG Parent and our Life Insurance Companies through internal, Board-approved policies and guidelines. In addition, AIG Parent is party to a CMA with AGC Life Insurance Company. Among other things, the CMA provides that AIG Parent will maintain the total adjusted capital of AGC Life Insurance Company at or above a specified minimum percentage of its projected NAIC Company Action Level Risk-Based Capital (RBC), which as of December 31, 2014, was 250 percent. As a result of managing capital through internal, Board-approved policies and guidelines, AIG Parent agreed with certain other domestic Life Insurance Companies to terminate their CMAs effective October 31, 2014.
Dividends and loan repayments from our domestic Life Insurance Companies to AIG Parent in 2014 totaled $7.4 billion, which was comprised of $6.8 billion of cash and fixed maturity securities and $642 million of preferred equity interests in two aircraft trust entities, and included approximately $829 million of legal settlement proceeds. The fixed maturity securities included investment-grade government, corporate and sovereign bonds, as well as agency RMBS. In addition, our domestic Life Insurance Companies paid $2.2 billion in dividends and loan repayments, in the form of cash and fixed maturity securities, to AIG Parent in January 2015, which represented the remainder of dividends that were declared by our domestic operating Life Insurance Companies in the fourth quarter of 2014.
From time to time, we may utilize cash allocated to the DIB that is not required to meet the risk target for the DIB for general corporate purposes unrelated to the DIB.
The DIB’s assets consist primarily of cash, short-term investments, fixed maturity securities issued by corporations, U.S. government and government sponsored entities and mortgage and asset backed securities. The value of these assets is impacted by macro-economic trends in U.S. and core European markets, including corporate credit spreads, commercial and residential real estate markets, and to a lesser extent, interest rates and foreign exchange rates, among other factors. The majority of these assets are carried at fair value. The DIB’s liabilities consist primarily of notes and other borrowings supported by assets as well as other short-term financing obligations. The DIB has both liabilities held at cost and liabilities held at fair value. The liabilities held at fair value vary in price based on changes in AIG’s credit spreads. As of December 31, 2014 and 2013, the DIB had total assets of $15.1 billion and $23.3 billion, respectively, and total liabilities of $9.7 billion and $20.0 billion, respectively.
Loss reserves relate to our Non-Life Insurance Companies and represent future losses 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 Non-Life Insurance Companies maintain adequate financial resources to meet the actual required payments under these obligations.
nature. 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.
(b) Includes commitments to invest in private equity funds, hedge funds and mutual funds and commitments to purchase and develop real estate in the United States and abroad. The commitments to invest in private equity funds, hedge funds and other funds are called at the discretion of each fund, as needed for funding new investments or expenses of the fund. The expiration of these commitments is estimated in the table above based on the expected life cycle of the related fund, consistent with past trends of requirements for funding. Investors under these commitments are primarily insurance and real estate subsidiaries.
(f) Includes a five-year senior unsecured revolving credit facility between AerCap Ireland Capital Limited, as borrower, and AIG Parent, as lender (the AerCap Credit Facility). The AerCap Credit Facility provides for an aggregate commitment of $1.0 billion and permits loans for general corporate purposes. At December 31, 2014, no amounts were outstanding under the AerCap Credit Facility.
We are subject to financial guarantees and indemnity arrangements in connection with our sales of businesses. These arrangements may be triggered by declines in asset values, specified business contingencies, the realization of contingent liabilities, litigation developments, or breaches of representations, warranties or covenants provided by us. These arrangements are typically subject to time limitations, defined by contract or by operation of law, such as by prevailing statutes of limitation. Depending on the specific terms of the arrangements, the maximum potential obligation may or may not be subject to contractual limitations. For additional information regarding our indemnification agreements, see Note 16 to the Consolidated Financial Statements.
(c) Reflects debt that has been reclassified from Other subsidiaries notes, bonds, loans and mortgages payable to Debt of consolidated investments.
(d) At December 31, 2014, includes debt of consolidated investments held through AIG Global Real Estate Investment Corp., AIG Credit Corp., AIGLH and AIG Property Casualty Inc. of $2.0 billion, $54 million, $1.5 billion and $122 million, respectively.
We are party to some agreements that contain “ratings triggers.” Depending on the ratings maintained by one or more rating agencies, these triggers could result in (i) the termination or limitation of credit availability or a requirement for accelerated repayment, (ii) the termination of business contracts or (iii) a requirement to post collateral for the benefit of counterparties.
In the event of adverse actions on our long-term debt ratings by the major rating agencies, AIGFP and certain other GCM entities would be required to post additional collateral under some derivative transactions or could experience termination of the transactions. Such requirements and terminations could adversely affect our business, our consolidated results of operations in a reporting period or our liquidity. In the event of a further downgrade of AIG’s long-term senior debt ratings, AIGFP and certain other GCM entities would be required to post additional collateral, and certain of the counterparties of AIGFP or of such other GCM entities would be permitted to terminate their contracts early.
For a discussion of the effects of downgrades in the financial strength ratings of our insurance companies or our credit ratings, see Note 11 to the Consolidated Financial Statements herein and Part I, Item 1A. Risk Factors - Liquidity, Capital and Credit.
On February 13, 2014, our Board of Directors declared a cash dividend on AIG Common Stock of $0.125 per share, payable on March 25, 2014 to shareholders of record on March 11, 2014. On May 5, 2014, our Board of Directors declared a cash dividend on AIG Common Stock of $0.125 per share, payable on June 24, 2014 to shareholders of record on June 10, 2014. On August 4, 2014, our Board of Directors declared a cash dividend on AIG Common Stock of $0.125 per share, payable on September 25, 2014 to shareholders of record on September 11, 2014. On November 3, 2014, our Board of Directors declared a cash dividend on AIG Common Stock of $0.125 per share, payable on December 18, 2014 to shareholders of record on December 4, 2014.
On February 12, 2015, our Board of Directors declared a cash dividend on AIG Common Stock of $0.125 per share, payable on March 26, 2015 to shareholders of record on March 12, 2015. 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.
On August 1, 2013, our Board of Directors authorized the repurchase of shares of AIG Common Stock, with an aggregate purchase price of up to $1.0 billion, from time to time in the open market, private purchases, through forward, derivative, accelerated repurchase or automatic repurchase transactions or otherwise. On February 13, 2014, June 5, 2014 and October 31, 2014, our Board of Directors authorized increases to the August 1, 2013 repurchase authorization of AIG Common Stock of an aggregate of $4.5 billion.
During 2014, we repurchased approximately 88 million shares of AIG Common Stock for an aggregate purchase price of approximately $4.9 billion pursuant to this authorization.
On February 12, 2015, our Board of Directors authorized an additional increase to the August 1, 2013 repurchase authorization of AIG Common Stock of $2.5 billion, resulting in an aggregate remaining authorization on such date of approximately $2.5 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. The timing of any future share repurchases will depend on market conditions, our financial condition, results of operations, liquidity and other factors.
Our risk governance structure fosters the development and maintenance of a risk and control culture that encompasses all significant risk categories. Accountability for the implementation and oversight of risk policies is aligned with individual corporate executives, with the risk committees receiving regular reports regarding compliance with each policy to support risk governance at our corporate level as well as in each business unit. We review our governance and committee structure on a regular basis and make changes as appropriate to continue to effectively manage and govern our risks and risk-taking.
Our Board of Directors oversees the management of risk through its Risk and Capital Committee (RCC) and Audit Committee. Those committees regularly interact with other committees of the Board of Directors. Our Chief Risk Officer (CRO) reports to both the RCC and AIG’s Chief Executive Officer (CEO).
The Group Risk Committee (GRC) is the senior management group charged with assessing all significant risk issues on a global basis to protect our financial strength, optimize our intrinsic value, and protect our reputation. The GRC is chaired by our CRO. Its membership includes our CEO, Chief Financial Officer (CFO), and other executives from across our corporate functions and business units. Our CRO reports periodically on behalf of the GRC to both the RCC and the Audit Committee of the Board of Directors.
Financial Risk Group (FRG): The FRG is responsible for the oversight of financial risks taken by AIG and its subsidiaries. Its mandate includes overseeing our aggregate credit, market, interest rate, capital, liquidity and model risks, as well as asset-liability management, derivatives activity, and foreign exchange transactions. Membership of the FRG includes our EVP -
Transaction Approval and Business Practices Committee (TABPC): TABPC provides the primary corporate-level review function for all proposed transactions and business practices that are significant in size, complex in scope, or that present heightened legal, reputational, accounting or regulatory risks. Our Deputy General Counsel serves as TABPC Chair and additional members include our CRO and CFO, and other senior executives from Finance, Legal, Treasury, Investments and our business units.
Our Risk Appetite Framework integrates stakeholder interests, strategic business goals and available financial resources. We intend to balance these by taking measured risks that are expected to generate repeatable, sustainable earnings and produce long-term value for our shareholders. The framework includes our Risk Appetite Statement approved by the Board of Directors
All limits are reviewed by the FRG, GRC or business unit level risk committees on a periodic basis and revisions, if applicable, are approved by those committees.
One tool we use to inform our Risk Appetite Framework is risk identification. We conduct risk identification through a number of processes at the business unit and corporate level focused on capturing our material risks and key areas of focus for follow-up risk management actions. A key initiative is our annual integrated bottom-up risk identification and assessment process
The stress testing framework assesses our aggregate exposure to our most significant financial and insurance risks, including the risk in each of our key insurance company subsidiaries in relation to its statutory capital needs under stress, risks inherent in our non-insurance company subsidiaries, and risks to AIG consolidated capital. Using our stress testing methodology, we evaluate the capital and earnings impact of potential stresses in relation to the relevant capital constraint of each business operation. We use this information to determine the resources needed at the AIG Parent level to support our subsidiaries and capital resources required to maintain consolidated company target capitalization levels.
We devote considerable resources to managing our direct and indirect credit exposures. These exposures may arise from, but are not limited to fixed income investments, equity securities, deposits, commercial paper investments, reverse repurchase agreements and repurchase agreements, corporate and consumer loans, leases, reinsurance recoverables, counterparty risk arising from derivatives activities, collateral extended to counterparties, insurance risk cessions to third parties, financial guarantees and letters of credit.
Our credit risks are overseen and managed by ERM. ERM is assisted by credit functions headed by highly experienced credit professionals that take and manage our credit risk. Their primary role is to assure appropriate credit risk management in accordance with our credit policies and procedures relative to our credit risk parameters. Our Chief Credit Officer (CCO) and credit executives are primarily responsible for the development, implementation and maintenance of a risk management framework, which includes the following elements related to our credit risks:
• approving appropriate credit reserves, credit-related other-than-temporary impairments and corresponding methodologies in all credit portfolios.
We are engaged in a variety of insurance, investment and other financial services businesses that generate market risk, directly and indirectly. We are exposed to market risks primarily within our insurance and capital markets businesses, on both the asset and liability side of our balance sheet through on and off-balance sheet exposures. The chief risk officer within each business is responsible for properly identifying these risks, then ensuring that they are appropriately measured, monitored and managed in accordance with the risk governance framework established by the Chief Market Risk Officer (CMRO).
The scope and magnitude of our market risk exposures is managed under a robust framework that contains documented risk-taking authorities, defined risk limits and minimum standards for managing market risk in a manner consistent with our Risk Appetite Statement. Our market risk management framework focuses on quantifying the financial repercussions of changes in these broad market observables, distinct from the idiosyncratic risks associated with individual assets that are addressed through our credit risk management function.
Market risk focuses on quantifying the financial repercussions of changes in broad, external, predominantly market observable risks. Financial repercussions can include an adverse impact on results of operations, financial conditions, liquidity and capital.
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 (REITs), and residential mortgage insurance contracts and commercial real estate investments.
Interest rates. Interest rate risk can arise from a mismatch in the interest rate exposure of assets versus liabilities. Lower interest rates generally result in lower investment income and resulting product changes will generally reduce the attractiveness of our insurance products in the marketplace. Conversely, higher interest rates are typically beneficial for the opposite reasons. However, when rates rise quickly, there can be a temporary asymmetric U.S. GAAP accounting effect where the existing securities lose market value, which is largely reported in Other comprehensive income, and the offsetting decrease in the value of related liabilities may not be recognized. Changes in interest rates can affect the valuation of fixed maturity securities, financial liabilities, insurance contracts including but not limited to fixed rate annuities, variable annuities and derivative contracts.
Credit spreads. Credit spreads measure an instrument’s risk premium or yield relative to that of a comparable duration, default-free instrument. Changes in credit spreads can affect the valuation of fixed maturity securities, including but not limited to corporate bonds, asset-backed securities, mortgage-backed securities, AIG-issued debt obligations, credit derivatives and derivative credit valuation adjustments. Much like higher interest rates, wider credit spreads mean more investment income in the long-term. In the short term, quickly rising spreads will cause a loss in the value of existing fixed maturity securities, which is largely reported in Other comprehensive income. A precipitous rise in credit spreads may also signal a fundamental weakness in the credit-worthiness of bond obligors, potentially resulting in default losses.
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.
Market risk is managed at the corporate level within ERM through the CMRO, who reports directly to the AIG CRO. The CMRO is supported by a dedicated team of professionals within ERM who work in partnership with the senior management of our finance, treasury and investment management corporate functions. The CMRO is primarily responsible for the development and maintenance of a risk management framework that includes the following key components:
• a limit framework that aligns with our Board-approved Risk Appetite Statement;
Foreign currency-denominated net asset position reflects our consolidated non-U.S. dollar assets less our consolidated non-U.S dollar liabilities on a U.S. GAAP basis. 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. We manage cash flow risk on our foreign currency-denominated debt issued by AIG Parent and use a variety of techniques to mitigate this risk, including but not limited to the execution of cross-currency swaps and the issuance of new foreign currency-denominated debt to replace equivalent maturing debt. At the AIG Parent level, we monitor our foreign currency exposures against single currency and aggregate currency portfolio limits. As a matter of general practice, we do not typically hedge our foreign currency exposures to net investments in subsidiaries. However, we may utilize either cross-currency swaps or our foreign currency- denominated debt as a net investment hedge of our capital in subsidiaries.
At December 31, 2014, our five largest foreign currency net asset positions were denominated in British pounds, Canadian dollars, Euro, Hong Kong dollars and Japanese yen. Our foreign currency-denominated net asset position at December 31, 2014 increased by 16.0 percent, or $1.7 billion, compared to December 31, 2013. The increase was mostly due to a $650 million increase in our Hong Kong dollar position, primarily resulting from the Non-Life Insurance Companies investment in PICC P&C; a $585 million increase in our British pound position, primarily resulting from AIG Parent repurchasing outstanding British pound-denominated debt; a $378 million increase in our Japanese yen position, mainly attributable to Japanese yen deferred tax liability reduction; a $153 million increase in our Canadian dollar position, mainly attributable to an increase in operating income from underwriting and investments; and a $75 million increase in our Euro position primarily resulting from AIG Parent repurchasing outstanding Euro-denominated debt. These increases were partially offset by a $173 million decrease in our Polish zloty position, primarily resulting from the sale of our equity investment in Santander Consumer Bank.
• a 10 percent depreciation of foreign currency exchange rates is consistent with a one standard deviation movement in the U.S. dollar (USD)/Great Britain pound (GBP) exchange rate.
• Event Funding Risk: Additional funding is 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 created a funding obligation or limits existing funding options.
Liquidity risk is managed at the corporate level within ERM through the CMRO, who reports directly to the AIG CRO. The AIG CRO has responsibility for the oversight of the Liquidity Risk Management Framework and delegates day-to-day implementation of this framework to the AIG Treasurer, with ERM oversight.
long-term viability and ability to fund our ongoing business, and to meet short-term financial obligations in a timely manner in both normal and stressed conditions.
Our Liquidity Risk Management Framework includes a number of liquidity and funding policies and monitoring tools to address AIG-specific, broader industry and market related liquidity events.
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 risk, but excludes business and strategy risks.
Operational risk is inherent in each of our business units and corporate functions. Operational risks can have many impacts, including but not limited to: unexpected economic losses or gains, reputational harm due to negative publicity, regulatory action from supervisory agencies, operational and business disruptions, and/or damage to customer relationships.
Each business unit is responsible for managing its operational risks and implementing the components of the operational risk management program. In addition, certain corporate control functions have been assigned accountability for enterprise-wide operational risk management for their respective areas. These control functions include Sarbanes-Oxley (SOX), Business Continuity Management (BCM), Information Technology Security Risk and Compliance, Model Validation and Vendor Risk
Management. Senior business operational risk executives report to their respective business unit CRO and to the Head of our ORM. This reporting structure is designed to enable close alignment with the business unit while ensuring consistent implementation of operational risk management practices.
We closely manage insurance risk by monitoring and controlling the nature and geographic location of the risks in each line of business underwritten, the terms and conditions of the underwriting and the premiums we charge for taking on the risk. We analyze concentrations of risk using various modeling techniques, including both probability distributions (stochastic) and/or single-point estimates (deterministic) approaches.
We purchase reinsurance for our insurance operations. Reinsurance facilitates insurance risk management (retention, volatility, concentrations) and capital planning. We may purchase reinsurance on a pooled basis. Pooling of our reinsurance risks enables us to purchase reinsurance more efficiently at a consolidated level, manage global counterparty risk and relationships and manage global catastrophe risks, both for the Non-Life Insurance Companies and the Life Insurance Companies.
Insurance risks are managed at the business unit level within ERM through the business unit chief risk officers, who report directly to the AIG CRO. Oversight is provided by the business unit chief risk officers. The business unit chief risk officers and their teams work closely with management to manage insurance risks. The framework includes the following key components:
In addition, we monitor concentrations of exposure through insurance limits aggregated along dimensions such as geography, industry, or counterparty.
• Underwriting - The potential inadequacy of premiums charged for future risk periods on risks underwritten in our portfolios can impact the Non-Life Insurance Companies ability to achieve an underwriting profit. We develop pricing based on our estimates of losses and expenses, but factors such as market pressures and the inherent uncertainty and complexity in estimating losses may result in premiums that are inadequate to generate underwriting profit. This may be driven by adverse economic conditions, unanticipated emergence of risks or increase in frequency of claims, worse than expected prepayment of policies, investment results, or expenses.
We perform post-catastrophe event studies to identify model weaknesses, underwriting gaps, and improvement opportunities. Lessons learned from post-catastrophe event studies are incorporated into the modeling and underwriting processes of risk pricing and selection. The majority of policies exposed to catastrophic risks are one-year contracts which allow us to adjust our underwriting guidelines, pricing and exposure accumulation in a relatively short period.
due to our relative share of exposure in those regions. Within the U.S., we have significant earthquake exposure in California, the Pacific Northwest and New Madrid regions. Earthquakes impacting the Pacific Northwest and New Madrid regions may result in a higher share of industry losses than other regions primarily due to our relative share of exposure in these regions.
(a) The U.S. hurricane amount includes losses to Property from hurricane hazards of wind and storm surge.
The OEP estimates provided above reflect our in-force portfolios at September 30, 2014, for U.S. exposures, and at June 30, 2014 for Japan exposures. The catastrophe reinsurance program is as of January 1, 2015.
Actual results in any period are likely to vary, perhaps materially, from the modeled scenarios. The occurrence of one or more severe events could have a material adverse effect on our financial condition, results of operations and liquidity. See also Item 1A. Risk Factors - Reserves and Exposures for additional information.
Terrorism Risk Insurance Act (TRIA) and reinsurance recoveries are estimated to be $3.1 billion as of September 30, 2014. We also have smaller terrorism exposure in Canadian cities and in London.
At December 31, 2014, total reinsurance recoverable assets were $22.0 billion. These assets include general reinsurance paid losses recoverable of $1.5 billion, ceded loss reserves of $15.7 billion including reserves for IBNR, and ceded reserves for unearned premiums of $3.0 billion, as well as life reinsurance recoverables of $1.8 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, 2014 reflects a reasonable estimate of the ultimate losses recoverable. Actual losses may, however, differ, perhaps materially, from the reserves currently ceded.
The Reinsurance Credit Department (RCD) conducts periodic detailed assessments of the financial strength and condition of current and potential reinsurers, both foreign and domestic. The RCD monitors both the financial condition of reinsurers as well as the total reinsurance recoverable ceded to reinsurers, and set limits with regard to the amount and type or exposure we are willing to take with reinsurers. As part of these assessments, we attempt to identify whether a reinsurer is appropriately licensed, assess its financial capacity and liquidity; and evaluate the local economic and financial environment in which a foreign reinsurer operates. The RCD reviews the nature of the risks ceded and the need for measures, including collateral to mitigate credit risk. For example, in our treaty reinsurance contracts, we frequently include provisions that require a reinsurer to post collateral or use other measures to reduce exposure when a referenced event occurs. Furthermore, we limit our unsecured exposure to reinsurers through the use of credit triggers such as insurer financial strength rating downgrades, declines in regulatory capital, or specified declines in risk-based capital (RBC) ratios. We also set maximum limits for reinsurance recoverable exposure, which in some cases is the recoverable amount plus an estimate of the maximum potential
(a) The financial strength ratings reflect the ratings of the various reinsurance subsidiaries of the companies listed as of February 10, 2015.
(b) Total reinsurance assets include both the Non-Life Insurance Companies and the Life Insurance Companies reinsurance recoverable.
(d) Includes $1.5 billion recoverable under the 2011 retroactive reinsurance transaction pursuant to which a large portion of the Non-Life 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. See Liability for Unpaid Losses and Loss Adjustment Expenses - Transfer of Domestic Asbestos Liabilities.
At December 31, 2014, we had no significant general reinsurance recoverable due from any individual reinsurer that was financially troubled. Reinsurer capital levels continued to increase in 2014, thereby increasing the industry’s underwriting capacity. This increased capacity has resulted in increased competition and lower rates for 2015 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 compliance with 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.
• Longevity risk - represents the risk of a change in value of a policy or benefit arising from actual mortality rates being lower than the expected mortality rates. This risk could arise from longer-term societal health changes as well as other factors. This risk exists in a number of our product lines but is most significant for our retirement, institutional and annuity products.
• Client behavioral risk including surrender/lapse risk - there are many assumptions made when products are sold including how long the contracts will persist. Actual experience can vary significantly from these assumptions. This risk is
impacted by a number of factors including changes in market conditions, tax law, regulations and policyholder preferences. This risk exists in the majority of our product lines.
• 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 (interest rate shock) but can also manifest itself over a longer period of time such as a persistent low interest rate environment.
• 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), universal life insurance, and variable universal life insurance. It also affects our equity investments and equity-related investments. In addition, changes in the volatility of equity prices can affect the valuation of those insurance products that are accounted for in a manner similar to equity derivatives.
GCM actively manages its exposures to limit potential economic losses, and in doing so, GCM must continually manage a variety of exposures including credit, market, liquidity and operational risks. The senior management of AIG defines the policies and establishes general operating parameters for GCM’s operations. Our senior management has established various oversight committees to regularly monitor various financial market, operational and credit risks related to GCM’s operations. The senior management of GCM reports the results of its operations to and reviews future strategies with AIG’s senior management.
The fair value of GCM’s interest rate, currency, credit, commodity and equity swaps, options, swaptions, and forward commitments, futures, and forward contracts reported in Derivative assets, at fair value, was approximately $1.4 billion at both December 31, 2014 and 2013. Where applicable, these amounts have been determined in accordance with the respective master netting agreements.
GCM evaluates counterparty credit quality by internal analysis consistent with the risk rating policies of ERM, and supplements such analysis with ratings from rating agencies, where applicable. In addition, GCM’s credit approval process involves pre-approved counterparty credit exposure limits that are established by ERM.
See Note 11 to the Consolidated Financial Statements for additional discussion related to derivative transactions.
Classification of ILFC as Held for Sale and Related Fair Value Measurement
The evaluation of the recoverability of our net deferred tax asset and the need for a valuation allowance requires us to weigh all positive and negative evidence to reach a conclusion that it is more likely than not that all or some portion of the net deferred tax asset will not be realized. The weight given to the evidence is commensurate with the extent to which it can be objectively verified. The more negative evidence that exists, the more positive evidence is necessary and the more difficult it is to support a conclusion that a valuation allowance is not needed.
See Note 24 to the Consolidated Financial Statements for a discussion of our framework for assessing the recoverability of our deferred tax asset.
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.
The U.S. federal income tax laws applicable to determining the amount of income taxes related to differences between the book carrying amounts and tax bases of subsidiaries are complex. Determining the amount also requires significant judgment and reliance on reasonable assumptions and estimates.
The estimate of the Liability for unpaid losses and loss adjustment expenses consists of several key judgments:
We use numerous assumptions in determining the best estimate of reserves for each class of business. The importance of any specific assumption can vary by both class 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 such as excess casualty, asbestos, D&O, and primary or excess workers’ compensation.
For operations writing short-tail coverages, such as property, the process for recording non-catastrophe quarterly loss reserves is generally geared toward maintaining incurred but not reported reserves based on percentages of net earned premiums for that business, rather than determining an ultimate loss ratio for current business based on reported losses. For example, the IBNR reserve required for the latest accident quarter for a class of property business might be expected to approximate 20 percent of the most recent quarter’s earned premiums. This level of reserve would generally be maintained regardless of the actual losses emerging in the current quarter. The percent of premium factor would reflect both the expected ultimate cost for reported claims and the expected percentage of losses that have not yet been reported. The expected ultimate loss costs generally reflect the average loss ratio from a period of preceding years that have been adjusted for changes in rate and loss cost levels, mix of business, known exposure to unreported losses, or other factors affecting the particular class of business. The expected percentage of losses that have not yet been reported would be derived from historical loss emergence patterns. IBNR for claims arising from catastrophic events or events of unusual severity would be determined using alternative techniques in close collaboration with the claims department. For some classes, a loss development factor method or percentage of monthly losses method may be used to determine IBNR reserves.
We continue to 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. In 2014, the third party actuarial reviews covered the majority of net reserves held for our Commercial long-tail classes of business, and run-off portfolios reported in Corporate and Other.
The actuarial methods we use for most long-tail casualty classes of business include loss development methods, expected loss ratio methods, including “Bornhuetter Ferguson” methods described below, and frequency/severity models. Loss development methods utilize the actual loss development patterns from prior accident years to project the reported losses to an ultimate basis for subsequent accident years. Loss development methods generally are most appropriate for classes of business which exhibit a stable pattern of loss development from one accident year to the next, and for which the components of the classes have similar development characteristics. For example, property exposures would generally not be combined into the same class as casualty exposures, and primary casualty exposures would generally not be combined into the same class as excess casualty exposures. In 2014, we continued to refine our loss reserving techniques for the domestic primary casualty classes of business and adopted further segmentations based on our analysis of the differing emerging loss patterns for certain classes of insureds. We generally use expected loss ratio methods in cases where the reported loss data lacks sufficient credibility to utilize loss development methods, such as for new classes of business or for long-tail classes at early stages of loss development. Frequency/severity models may be used where sufficient frequency counts are available to apply such approaches.
of the accident year would be added to determine the total ultimate loss estimate for the accident year. Subtracting the reported paid losses and loss adjustment expenses would result in the indicated loss reserve. In the example above, the expected loss ratio of 70 percent would be multiplied by 90 percent. The result of 63 percent would be applied to the earned premium of $10 million resulting in an estimated unreported loss of $6.3 million. Actual reported losses would be added to arrive at the total ultimate losses. If the reported losses were $1 million, the ultimate loss estimate under the “Bornhuetter Ferguson” method would be $7.3 million versus the $7 million amount under the expected loss ratio method described above. Thus, the “Bornhuetter Ferguson” method gives partial credibility to the actual loss experience to date for the class of business. Loss development methods generally give full credibility to the reported loss experience to date. In the example above, loss development methods would typically indicate an ultimate loss estimate of $10 million, as the reported losses of $1 million would be estimated to reflect only 10 percent of the ultimate losses.
A key advantage of loss development methods is that they respond quickly to any actual changes in loss costs for the class of business. Therefore, if loss experience is unexpectedly deteriorating or improving, the loss development method gives full credibility to the changing experience. Expected loss ratio methods would be slower to respond to the change, as they would continue to give more weight to the expected loss ratio, until enough evidence emerged to modify the expected loss ratio to reflect the changing loss experience. On the other hand, loss development methods have the disadvantage of overreacting to changes in reported losses if the loss experience is not credible. For example, the presence or absence of large losses at the early stages of loss development could cause the loss development method to overreact to the favorable or unfavorable experience by assuming it will continue at later stages of development. In these instances, expected loss ratio methods such as “Bornhuetter Ferguson” have the advantage of recognizing large losses without extrapolating unusual large loss activity onto the unreported portion of the losses for the accident year.
We continue to receive claims asserting injuries and damages from toxic waste, hazardous substances, and other environmental pollutants and alleged claims to cover the cleanup costs of hazardous waste dump sites, referred to collectively as environmental claims, and indemnity claims asserting injuries from asbestos. The vast majority of these asbestos and environmental claims emanate from policies written in 1984 and prior years. Commencing in 1985, standard policies contained absolute exclusions for pollution-related damage and asbestos. The current Non-Life Insurance Companies Environmental policies that we specifically price and underwrite for environmental risks on a claims-made basis have been excluded from the analysis.
The environmental claims unit also actively manages and pursues early resolution with respect to these claims in an attempt to mitigate its exposure to the unpredictable development of these claims. We attempt to mitigate our known long-tail environmental exposures through a combination of proactive claim-resolution techniques, including policy buybacks, complete environmental releases, compromise settlements, and, when appropriate, litigation.
The estimation of reinsurance recoverable involves a significant amount of judgment, particularly for latent exposures, such as asbestos, due to their long-tail nature. Reinsurance assets include reinsurance recoverable on unpaid losses and loss adjustment expenses that are estimated as part of our loss reserving process and, consequently, are subject to similar judgments and uncertainties as the estimation of gross loss reserves.
We assess the collectability of reinsurance recoverable balances through either detailed reviews of the underlying nature of the reinsurance balance or comparisons with historical trends of disputes and credit events. We record adjustments to reflect the results of these assessments through an allowance for uncollectable reinsurance that reduces the carrying amount of reinsurance assets in the balance sheet. This estimate requires significant judgment for which key considerations include:
Loss recognition occurs if observed changes in actual experience or estimates result in projected future losses under loss recognition testing. To determine whether loss recognition exists, we determine whether a future loss is expected based on updated current assumptions. If a loss recognition exists, we recognize the loss by first reducing DAC through amortization expense, and, if DAC is depleted, record additional liabilities through a charge to policyholder benefit expense. See Note 9 to the Consolidated Financial Statements for additional information on loss recognition. Because of the long-term nature of many of our liabilities subject to the “lock-in” principle, small changes in certain assumptions may cause large changes in the degree of reserve adequacy. In particular, changes in estimates of future invested asset returns have a large effect on the degree of reserve deficiency.
• 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 scenarios.
The Life operating segment recorded loss recognition expense of $87 million in 2014 and $67 million in 2012 to increase reserves for certain discontinued long-term care business as a result of updated assumptions. Sales of investment securities in connection with our program to utilize capital loss carryforwards and other investment sales with subsequent reinvestment at lower yields triggered recording of loss recognition expense of $30 million, $1.5 billion and $1.2 billion in 2014, 2013 and 2012, respectively, primarily related to certain long-term payout annuity contracts in the Institutional Markets and Retirement operating segments. See Results of Operations - Life Insurance Companies DAC and Reserves - Loss Recognition for additional discussion.
Policy acquisition costs and policy issuance costs that are incremental and directly related to the successful acquisition of new or renewal of existing insurance contracts related to universal life and investment-type products (collectively, investment-oriented products) are generally deferred and amortized, with interest, in relation to the incidence of estimated gross profits to be realized over a period that approximates the estimated lives of the contracts, except in instances where significant negative gross profits are expected in one or more periods. Estimated gross profits include net investment income and spreads, net realized investment gains and losses, fees, surrender charges, expenses, and mortality gains and losses. In estimating future gross profits, lapse assumptions require judgment and can have a material impact on DAC amortization. For fixed deferred annuity contracts, the future spread between investment income and interest credited to policyholders is a significant judgment, particularly in a low interest rate environment.
(c) Represents the net impact of 10 basis point parallel shift in the yield curve on the reserves for GMWB and GMAV living benefit features. Does not represent interest rate spread compression on investment-oriented products.
The analysis of DAC, guaranteed benefits reserve and unearned revenue liability is a dynamic process that considers all relevant factors and assumptions described above. We estimate each of the above factors individually, without the effect of
any correlation among the key assumptions. An assessment of sensitivity associated with changes in any single assumption would not necessarily be an indicator of future results. The effects on pre-tax earnings in the sensitivity analysis table above do not reflect the related effects from our economic hedging program, which utilizes derivative and other financial instruments and is designed so that changes in value of those instruments move in the opposite direction of changes in the guaranteed benefit embedded derivative liabilities. For a further discussion on guaranteed benefit features of our variable annuities, our dynamic hedging program and risks of AIG’s unhedged exposures, see Item 1A. - Risk Factors - Business and Operations and Notes 5 and 14 to the Consolidated Financial Statements.
See Note 5 to the Consolidated Financial Statements for additional information about the measurement of fair value of financial assets and financial liabilities and our accounting policy regarding the incorporation of credit risk in fair value measurements.
(a) Includes $27.3 billion for which the primary source is broker quotes.
Loss reserve development The increase or decrease in incurred losses and loss adjustment expenses as a result of the re-estimation of liability for unpaid losses and loss adjustment expenses at successive valuation dates for a given group of claims.
Pool A reinsurance arrangement whereby all of the underwriting results of the pool members are combined and then shared by each member in accordance with its pool participation percentage. Prior to January 1, 2014, AIG maintained two pools (the admitted lines pool and the surplus lines pool. Our members in the admitted lines pool are licensed to write standard lines of business by the individual state departments of insurance, and the policy forms and rates are regulated by those departments. Our members in the surplus lines pool provide policyholders with insurance coverage for risks which are generally not available in the standard insurance market. Surplus lines policy forms and rates are not regulated by the insurance departments. Effective January 1, 2014, these two pools were merged into one combined pool (the combined pool).
Premiums and deposits - Institutional Markets include direct and assumed amounts received and earned on group benefit policies and life-contingent payout annuities, deposits received on investment-type annuity contracts including GICs.
Premiums and deposits - Retirement and - Life include direct and assumed amounts received on traditional life insurance policies, 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.
Reinsurance The practice whereby one insurer, the reinsurer, in consideration of a premium paid to that insurer, agrees to indemnify another insurer, the ceding company, for part or all of the liability of the ceding company under one or more policies or contracts of insurance which it has issued.
Surrender charge A charge levied against an investor for the early withdrawal of funds from a life insurance or annuity contract, or for the cancellation of the agreement.
Reinsurance at December 31, 2014, 2013 and 2012 and for the years then ended
Valuation and Qualifying Accounts at December 31, 2014, 2013 and 2012 and for the years then ended
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 through the date of the completion of the sale. ILFC’s assets and liabilities were classified as held-for-sale at December 31, 2013 in the Consolidated Balance Sheets. See Note 4 herein for further discussion.
• valuation of liabilities for guaranteed benefit features of variable annuity products;
• estimated gross profits to value deferred acquisition costs for investment-oriented products;
• impairment charges, including other-than-temporary impairments on available for sale securities, impairments on investments in life settlements and goodwill impairment;
These accounting estimates require the use of assumptions about matters, some of which are highly uncertain at the time of estimation. To the extent actual experience differs from the assumptions used, our consolidated financial conditions, results of operations and cash flows could be materially affected.
Other income includes unrealized gains and losses on derivatives, including income from the Direct Investment book (DIB) unrealized market valuation gains and losses associated with the Global Capital Markets (GCM) super senior credit default swap (CDS) portfolio, advisory fee income from the Consumer Insurance broker dealer business, as well as legal settlements of $804 million, $1.2 billion and $200 million from legacy crisis and other matters in 2014, 2013 and 2012, respectively.
• Change in fair value relating to financial assets and liabilities for which the fair value option has been elected.
• Interest income and related expenses, including amortization of premiums and accretion of discounts on bonds with changes in the timing and the amount of expected principal and interest cash flows reflected in the yield, as applicable.
• Dividend income from common and preferred stock and distributions from other investments.
• Gains and losses recognized in earnings on derivatives for the effective portion and their related hedged items.
Premiums and other receivables - net of allowance include premium balances receivable, amounts due from agents and brokers and policyholders, trade receivables for the DIB and GCM and other receivables. Trade receivables for GCM include cash collateral posted to derivative counterparties that is not eligible to be netted against derivative liabilities. The allowance for doubtful accounts on premiums and other receivables was $428 million and $554 million at December 31, 2014 and 2013, respectively.
We offer sales inducements which include enhanced crediting rates or bonus payments to contract holders (bonus interest) on certain annuity and investment contract products. Sales inducements provided to the contract holder are recognized in Policyholder contract deposits in the Consolidated Balance Sheets. Such amounts are deferred and amortized over the life of the contract using the same methodology and assumptions used to amortize DAC (see Note 9 herein). To qualify for such accounting treatment, the bonus interest must be explicitly identified in the contract at inception. We must also demonstrate that such amounts are incremental to amounts we credit on similar contracts without bonus interest, and are higher than the contract’s expected ongoing crediting rates for periods after the bonus period. The deferred bonus interest and other deferred sales inducement assets totaled $629 million and $703 million at December 31, 2014 and 2013, respectively. The amortization expense associated with these assets is reported within Interest credited to policyholder account balances in the Consolidated Statements of Income. Such amortization expense totaled $63 million, $102 million and $162 million for the years ended December 31, 2014, 2013 and 2012, respectively.
Separate accounts represent funds for which investment income and investment gains and losses accrue directly to the policyholders who bear the investment risk. Each account has specific investment objectives and the assets are carried at fair value. The assets of each account are legally segregated and are not subject to claims that arise from any of our other businesses. The liabilities for these accounts are equal to the account assets. For a more detailed discussion of separate accounts, see Note 14 herein.
In February 2013, the Financial Accounting Standards Board (FASB) issued an accounting standard that requires us to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date as the sum of (i) the amount we agreed to pay on the basis of our arrangement among our co-obligors and (ii) any additional amount we expect to pay on behalf of our co-obligors.
In March 2013, the FASB issued an accounting standard addressing whether consolidation guidance or foreign currency guidance applies to the release of the cumulative translation adjustment into net income when a parent sells all or a part of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or net assets that are a business (other than a sale of in-substance real estate) within a foreign entity. The standard also resolves the diversity in practice for the cumulative translation adjustment treatment in business combinations achieved in stages involving foreign entities.
Under the standard, the entire amount of the cumulative translation adjustment associated with the foreign entity should be released into earnings when there has been: (i) a sale of a subsidiary or group of net assets within a foreign entity and the sale represents a complete or substantially complete liquidation of the foreign entity in which the subsidiary or the net assets had resided; (ii) a loss of a controlling financial interest in an investment in a foreign entity; or (iii) a change in accounting method from applying the equity method to an investment in a foreign entity to consolidating the foreign entity.
qualifies as an investment company. Entities that are not regulated under the 1940 Act must have certain fundamental characteristics and must consider other characteristics to determine whether they qualify as investment companies. An entity’s purpose and design must be considered when making the assessment.
An entity that no longer meets the requirements to be an investment company as a result of this standard should present the change in its status as a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. An entity that is an investment company should apply the standard prospectively as an adjustment to opening net assets as of the effective date. The adjustment to net assets represents both the difference between the fair value and the carrying amount of the entity’s investments and any amount previously recognized in Accumulated other comprehensive income.
We adopted the standard on its required effective date of January 1, 2014 on a prospective basis. The adoption of this standard had no material effect on our consolidated financial condition, results of operations or cash flows.
In April 2014, the FASB issued an accounting standard that changes the requirements for presenting a component or group of components of an entity as a discontinued operation and requires new disclosures. Under the standard, the disposal of a component or group of components of an entity should be reported as a discontinued operation if the disposal represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results. Disposals of equity method investments, or those reported as held-for-sale, must be presented as a discontinued operation if they meet the new definition. The standard also requires entities to provide disclosures about the disposal of an individually significant component of an entity that does not qualify for discontinued operations presentation.
The standard is effective prospectively for all disposals of components (or classification of components as held-for-sale) of an entity that occur within interim and annual periods beginning on or after December 15, 2014. Early adoption is permitted, but only for disposals (or classifications of components as held-for-sale) that have not been reported in financial statements
The accounting standard and new disclosure requirements for certain transactions accounted for as sales are effective for interim and annual reporting periods beginning after December 15, 2014, while the disclosure requirements for transactions accounted for as secured borrowings are effective for annual reporting periods beginning after December 15, 2014 and for interim reporting periods beginning after March 15, 2015. Early adoption is not permitted. We plan to adopt the standard on its required effective dates and do not expect the adoption of the standard to have a material effect on our consolidated financial condition, results of operations or cash flows.
The standard is effective for interim and annual reporting periods beginning after December 15, 2015. Early adoption is permitted. The standard may be applied retrospectively to all relevant prior periods presented starting with January 1, 2010 or through a cumulative effect adjustment to retained earnings at the date of adoption. We plan to adopt the standard on its required effective date of January 1, 2016 and are assessing the impact of the standard on our consolidated financial condition, results of operations or cash flows
In February 2015, the FASB issued an accounting standard that affects reporting entities that are required to evaluate whether they should consolidate certain legal entities. Specifically, the amendments modify the evaluation of whether limited partnerships and similar legal entities are VIEs or voting interest entities; eliminate the presumption that a general partner should consolidate a limited partnership; affect the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships; and provide a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds.
The standard is effective for interim and annual reporting periods beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. The standard may be applied retrospectively or through a cumulative effect adjustment to retained earnings as of the beginning of the year of adoption. We plan to adopt the standard on its required effective date of January 1, 2016 and are assessing the impact of the standard on our consolidated financial condition, results of operations and cash flows.
To align our financial reporting with the manner in which AIG’s chief operating decision makers review the businesses to assess performance and make decisions about resources to be allocated, the Commercial and Consumer reportable segments are presented as three operating segments for each reportable segment as follows:
• Mortgage Guaranty - previously reported within the Corporate and Other Category
• Retirement - consists of the product lines Fixed Annuities, Retirement Income Solutions, Group Retirement, and Retail Mutual Funds and Advisory Services, previously included in AIG Life and Retirement’s Retail and Institutional operating segments.
Investment income is allocated between the Property Casualty and Personal Insurance operating segments based on an internal investment income allocation model. The model estimates investable funds based primarily on loss reserves and allocated capital.
Prior periods have been revised to conform to the current period presentation for the above segment changes.
* 2013 includes Aircraft Leasing assets classified as assets held-for-sale on the Consolidated Balance Sheets.
On May 14, 2014, we completed the sale of 100 percent of the common stock of ILFC to AerCap Ireland Limited, a wholly owned subsidiary of AerCap, in exchange for total consideration of approximately $7.6 billion, including cash and 97.6 million newly issued AerCap common shares, valued at approximately $4.6 billion based on AerCap’s closing price per share of $47.01 on May 13, 2014. Net cash proceeds to AIG were $2.4 billion after the settlement of intercompany loans, and AIG recorded pre-tax and after-tax gains of approximately $2.2 billion and $1.4 billion, respectively, for the year ended December
31, 2014. In connection with the AerCap Transaction, we entered into a five-year credit agreement for a senior unsecured revolving credit facility between AerCap Ireland Capital Limited, as borrower, and AIG Parent as lender (the Revolving Credit Facility). The Revolving Credit Facility provides for an aggregate commitment of $1.0 billion and permits loans for general corporate purposes after the closing of the AerCap Transaction. At December 31, 2014, no amounts were outstanding under the Revolving Credit Facility.
ILFC’s results of operations are reflected in Aircraft leasing revenue and Aircraft leasing expenses in the Consolidated Statements of Income through the date of the completion of the sale. ILFC’s assets and liabilities were classified as held-for-sale at December 31, 2013 in the Consolidated Balance Sheets.
The results of operations for the following business is presented as discontinued operations in our Consolidated Statements of Income.
In connection with the 2010 sale of American Life Insurance Company (ALICO) to MetLife, Inc. (MetLife), we recognized the following income (loss) from discontinued operations:
measuring fair value. Financial instruments with quoted prices in active markets generally have more pricing observability and less judgment is used in measuring fair value. Conversely, financial instruments for which no quoted prices are available have less observability and are measured at fair value using valuation models or other pricing techniques that require more judgment. Pricing observability is affected by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established, the characteristics specific to the transaction, liquidity and general market conditions.
• Our Own Credit Risk. Fair value measurements for certain liabilities incorporate our own credit risk by determining the explicit cost for each counterparty to protect against its net credit exposure to us at the balance sheet date by reference to observable AIG CDS or cash bond spreads. A derivative counterparty’s net credit exposure to us is determined based on master netting agreements, when applicable, which take into consideration all derivative positions with us, as well as collateral we post with the counterparty at the balance sheet date. We calculate the effect of these credit spread changes using discounted cash flow techniques that incorporate current market interest rates.
The cost of credit protection is determined under a discounted present value approach considering the market levels for single name CDS spreads for each specific counterparty, the mid market value of the net exposure (reflecting the amount of protection required) and the weighted average life of the net exposure. CDS spreads are provided to us by an independent third party. We utilize an interest rate based on the benchmark London Interbank Offered Rate (LIBOR) curve to derive our discount rates.
When our independent third-party valuation service providers are unable to obtain sufficient market observable information upon which to estimate the fair value for a particular security, fair value is determined either by requesting brokers who are knowledgeable about these securities to provide a price quote, which is generally non-binding, or by employing market accepted valuation models. Broker prices may be based on an income approach, which converts expected future cash flows to a single present value amount, with specific consideration of inputs relevant to particular security types. For structured securities, such inputs may include ratings, collateral types, geographic concentrations, underlying loan vintages, loan delinquencies and defaults, prepayments, and weighted average coupons and maturities. When the volume or level of market
activity for a security is limited, certain inputs used to determine fair value may not be observable in the market. Broker prices may also be based on a market approach that considers recent transactions involving identical or similar securities. Fair values provided by brokers are subject to similar control processes to those noted above for fair values from independent third-party valuation service providers, including management reviews. For those corporate debt instruments (for example, private placements) that are not traded in active markets or that are subject to transfer restrictions, valuations reflect illiquidity and non-transferability, based on available market evidence. When observable price quotations are not available, fair value is determined based on discounted cash flow models using discount rates based on credit spreads, yields or price levels of comparable securities, adjusted for illiquidity and structure. Fair values determined internally are also subject to management review to ensure that valuation models and related inputs are reasonable.
Certain variable annuity and equity-indexed annuity and life contracts contain embedded policy derivatives that we bifurcate from the host contracts and account for separately at fair value, with changes in fair value recognized in earnings. These embedded derivatives are classified within Policyholder contract deposits. We have concluded these contracts contain (i) written option guarantees on minimum accumulation value, (ii) a series of written options that guarantee withdrawals from the highest anniversary value within a specific period or for life, or (iii) equity-indexed written options that meet the criteria of derivatives that must be bifurcated.
With respect to embedded policy derivatives in our variable annuity contracts, because of the dynamic and complex nature of the expected cash flows, risk neutral valuations are used. Estimating the underlying cash flows for these products involves judgments regarding expected market rates of return, market volatility, correlations of market variables to funds, fund performance, discount rates and policyholder behavior. The portion of fees attributable to the fair value of expected benefit payments are included within the fair value measurement of these embedded policy derivatives and related fees are classified in net realized gain/loss as collected consistent with other changes in the fair value of these embedded policy derivatives. Any additional fees not attributed to the embedded derivative are excluded from the fair value measurement and classified in policy fees as collected.
We value CDS transactions written on the super senior risk layers of designated pools of debt securities or loans using internal valuation models, third-party price estimates and market indices. The principal market was determined to be the market in which super senior CDSs of this type and size would be transacted, or have been transacted, with the greatest volume or level of activity. We have determined that the principal market participants, therefore, would consist of other large financial institutions who participate in sophisticated over-the-counter derivatives markets. The specific valuation methodologies vary based on the nature of the referenced obligations and availability of market prices.
Our valuation methodologies for the super senior CDS portfolio have evolved over time in response to market conditions and the availability of market observable information. We have sought to calibrate the methodologies to available market information and to review the assumptions of the methodologies on a regular basis.
Multi-sector CDO portfolios: We use a modified version of the Binomial Expansion Technique (BET) model to value our CDS portfolio written on super senior tranches of multi-sector CDOs of ABS. The BET model was developed in 1996 by a major rating agency to generate expected loss estimates for CDO tranches and derive a credit rating for those tranches, and remains widely used.
Prices for the individual securities held by a CDO are obtained in most cases from the CDO collateral managers, to the extent available. CDO collateral managers provided market prices for 49 percent and 46 percent of the underlying securities used in the valuation at December 31, 2014 and 2013. When a price for an individual security is not provided by a CDO collateral manager, we derive the price through a pricing matrix using prices from CDO collateral managers for similar securities. Matrix pricing is a mathematical technique used principally to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the relationship of the security to other benchmark quoted securities. Substantially all of the CDO collateral managers who provided prices used dealer prices for all or part of the underlying securities, in some cases supplemented by independent third-party valuation service providers.
Corporate debt/Collateralized loan obligation (CLO) portfolios: For CDSs written on portfolios of investment-grade corporate debt, we use a mathematical model that produces results that are closely aligned with prices received from third parties. This methodology uses the current market credit spreads of the names in the portfolios along with the base correlations implied by the current market prices of comparable tranches of the relevant market traded credit indices as inputs.
We estimate the fair value of our obligations resulting from CDSs written on CLOs to be equivalent to the par value less the current market value of the referenced obligation. Accordingly, the value is determined by obtaining third-party quotations on the underlying super senior tranches referenced under the CDS contract.
(a) Represents netting of derivative exposures covered by qualifying master netting agreements.
(b) Effective April 1, 2014, we reclassified cross-currency swaps from Interest Rate contracts to Foreign exchange contracts. This change was applied prospectively.
The following tables present changes during the years ended December 31, 2014 and 2013 in Level 3 assets and liabilities measured at fair value on a recurring basis, and the realized and unrealized gains (losses) related to the Level 3 assets and liabilities in the Consolidated Balance Sheets at December 31, 2014 and 2013:
There were no significant transfers of derivative or other liabilities into or out of Level 3 for the years ended December 31, 2014 and 2013.
Embedded derivatives within Policyholder contract deposits relate to guaranteed minimum withdrawal benefits (GMWB) within variable annuity products and certain enhancements to interest crediting rates based on market indices within index annuities and guaranteed investment contracts (GICs). GMWB represents our largest exposure of these embedded derivatives, although the carrying amount of the liability fluctuates based on the performance of the equity markets and therefore, at a point in time, can be low relative to the exposure. The principal unobservable input used for GMWBs and embedded derivatives in index annuities measured at fair value is equity implied volatility. For GMWBs, other significant unobservable inputs include base and dynamic lapse rates, mortality rates, and utilization rates. Lapse, mortality, and utilization rates may vary significantly depending upon age groups and duration. In general, increases in volatility and utilization rates will increase the fair value of the liability associated with GMWB, while increases in lapse rates and mortality rates will decrease the fair value of the liability. Significant unobservable inputs used in valuing embedded derivatives within GICs include long-term forward interest rates and foreign exchange rates. Generally, the embedded derivative liability for GICs will increase as interest rates decrease or if the U.S. dollar weakens compared to the euro.
Private equity fund investments included above are not redeemable, as distributions from the funds will be received when underlying investments of the funds are liquidated. Private equity funds are generally expected to have 10-year lives at their inception, but these lives may be extended at the fund manager’s discretion, typically in one or two-year increments. At December 31, 2014, assuming average original expected lives of 10 years for the funds, 72 percent of the total fair value using net asset value per share (or its equivalent) presented above would have expected remaining lives of three years or less, 18 percent between four and six years and 10 percent between seven and 10 years.
The hedge fund investments included above are generally redeemable monthly (14 percent), quarterly (49 percent), semi-annually (15 percent) and annually (22 percent), with redemption notices ranging from one day to 180 days. At December 31, 2014, however, investments representing approximately 43 percent of the total fair value of the hedge fund investments cannot be redeemed, either in whole or in part, because the investments include various contractual restrictions. The majority of these contractual restrictions, which may have been put in place at the fund’s inception or thereafter, have pre-defined end dates and are generally expected to be lifted by the end of 2015. The fund investments for which redemption is restricted only in part generally relate to certain hedge funds that hold at least one investment that the fund manager deems to be illiquid.
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, 2014 or 2013.
We measure the fair value of certain assets on a non-recurring basis, generally quarterly, annually or when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. These assets include cost and equity-method investments, investments in life settlements, collateral securing foreclosed loans and real estate and other fixed assets, goodwill and other intangible assets. See Note 6 herein for additional information about how we test various asset classes for impairment.
Bonds held to maturity are carried at amortized cost when we have the ability and positive intent to hold these securities until maturity. When we do not have the ability or positive intent to hold bonds until maturity, these securities are classified as available for sale or are measured at fair value at our election. None of our fixed maturity securities met the criteria for held to maturity classification at December 31, 2014 or 2013.
For the years ended December 31, 2014, 2013 and 2012, the aggregate fair value of available for sale securities sold was $25.3 billion, $35.9 billion and $40.3 billion, which resulted in net realized capital gains of $0.7 billion, $2.5 billion and $3.1 billion, respectively.
(a) Includes hedge funds, private equity funds, affordable housing partnerships, and other investment partnerships.
We account for hedge funds, private equity funds, affordable housing partnerships and other investment partnerships using the equity method of accounting unless our interest is so minor that we may have virtually no influence over partnership operating and financial policies, or we have elected the fair value option. Under the equity method of accounting, our carrying amount generally is our share of the net asset value of the funds or the partnerships, and changes in our share of the net asset values are recorded in Net investment income with the exception of investments of AIG’s Corporate and Other category, for which such changes are reported in Other income. In applying the equity method of accounting, we consistently use the most recently available financial information provided by the general partner or manager of each of these investments, which is one to three months prior to the end of our reporting period. The financial statements of these investees are generally audited annually.
The following is the aggregated summarized financial information of our equity method investees, including those for which the fair value option has been elected:
Summarized financial information for these equity method investees may be presented on a lag, due to the unavailability of information for the investees at our respective balance sheet dates, and is included for the periods in which we held an equity method ownership interest.
• Dividend income from common and preferred stocks and distributions from other investments.
• Sales of available for sale fixed maturity securities, available for sale equity securities and real estate.
• Changes in fair value of derivatives except for (1) those instruments at AIGFP that are not intermediated on behalf of other AIG subsidiaries and (2) those instruments that are designated as hedging instruments when the change in the fair value of the hedged item is not reported in Net realized capital gains (losses).
The following table presents the components of Net realized capital gains (losses):
Certain GIAs have provisions that require collateral to be posted or payments to be made by us upon a downgrade of our long-term debt ratings. The actual amount of collateral required to be posted to the counterparties in the event of such downgrades, and the aggregate amount of payments that we could be required to make, depend on market conditions, the fair value of outstanding affected transactions and other factors prevailing at and after the time of the downgrade. The fair value of securities pledged as collateral with respect to these obligations approximated $3.5 billion and $4.2 billion at December 31, 2014 and 2013, 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.
The following table presents the composition of Mortgages and other loans receivable:
The following table presents the credit quality indicators for commercial mortgage loans:
During 2014 and 2013, loans with a carrying value of $218 million and $91 million were modified in TDRs, respectively.
For the years ended December 31, 2014, 2013 and 2012, reinsurance recoveries, which reduced losses and loss adjustment expenses incurred, amounted to $2.6 billion, $3.3 billion and $4.5 billion, respectively.
Long-duration reinsurance recoveries, which reduced Policyholder benefits and losses incurred, were approximately $731 million, $714 million and $758 million, respectively, for the years ended December 31, 2014, 2013 and 2012.
The following table presents long-duration insurance in-force ceded to other insurance companies:
The domestic Life Insurance Companies utilize internal and third-party reinsurance relationships to manage insurance risks and to facilitate capital management strategies, which allows them to minimize the use of letters of credit and utilize capital more efficiently. Pools of highly-rated third-party reinsurers are utilized to manage net amounts at risk in excess of retention limits.
The domestic Life Insurance Companies manage the capital impact on their statutory reserve requirements under the NAIC Model Regulation “Valuation of Life Insurance Policies” (Regulation XXX) and NAIC Actuarial Guideline 38 (Guideline AXXX) through intercompany reinsurance transactions. Under GAAP, these intercompany reinsurance transactions are eliminated in consolidation. Under one arrangement, one of the domestic Life Insurance Companies obtains letters of credit to support statutory recognition of the ceded reinsurance. As of December 31, 2014, the domestic Life Insurance Companies had two bilateral letters of credit totaling $450 million with AIG entities, which were issued on February 7, 2014 and expire on February 7, 2019, but will be automatically extended without amendment by one year on each anniversary of the issuance date, unless the issuer provides notice of non-renewal. See Note 20 for additional information on the use of affiliated reinsurance for Regulation XXX and Guideline AXXX reserves.
Long-duration insurance contracts: Policy acquisition costs for participating life, traditional life and accident and health insurance products are generally deferred and amortized, with interest, over the premium paying period. The assumptions used to calculate the benefit liabilities and DAC for these traditional products are set when a policy is issued and do not change with changes in actual experience, unless a loss recognition event occurs. These “locked-in” assumptions include mortality, morbidity, persistency, maintenance expenses and investment returns, and include margins for adverse deviation to reflect uncertainty given that actual experience might deviate from these assumptions. A loss recognition event occurs when there is a shortfall between the carrying amounts of future policy benefit liabilities net of DAC and the amount the future policy benefit liabilities net of DAC would be when applying updated current assumptions. When we determine a loss recognition event has occurred, we first reduce any DAC related to that block of business through amortization of acquisition expense, and after DAC is depleted, we record additional liabilities through a charge to Policyholder benefits and losses incurred. Groupings for loss recognition testing are consistent with our manner of acquiring and servicing the business and applied by product groupings. We perform separate loss recognition tests for traditional life products, payout annuities and long-term care products. 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.
Investment-oriented contracts: Policy acquisition costs and policy issuance costs related to universal life and investment-type products (collectively, investment-oriented products) are deferred and amortized, with interest, in relation to the incidence of estimated gross profits to be realized over the estimated lives of the contracts. Estimated gross profits include net investment income and spreads, net realized investment gains and losses, fees, surrender charges, expenses, and mortality gains and losses. In each reporting period, current period amortization expense is adjusted to reflect actual gross profits. If estimated gross profits change significantly, DAC is recalculated using the new assumptions, and any resulting adjustment is included in income. If the new assumptions indicate that future estimated gross profits are higher than previously estimated, DAC will be increased resulting in a decrease in amortization expense and increase in income in the current period; if future estimated gross profits are lower than previously estimated, DAC will be decreased resulting in an increase in amortization expense and decrease in income in the current period. Updating such assumptions may result in acceleration of amortization in some products and deceleration of amortization in other products. DAC is grouped consistent with the manner in which the insurance contracts are acquired, serviced and measured for profitability and is reviewed for recoverability based on the current and projected future profitability of the underlying insurance contracts.
* Net of reductions in DAC of $1.4 billion, $1.1 billion, and $1.8 billion for Life Insurance Companies at December 31, 2014, 2013 and 2012, 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, 2014 expected to be amortized in 2015 through 2019 by year is: 10.1 percent, 8.9 percent, 7.9 percent, 7.2 percent and 6.7 percent, respectively, with 59.2 percent being amortized
(a) Comprised primarily of Short-term investments, Premiums and other receivables and Other assets at both December 31, 2014 and 2013.
(d) At December 31, 2014 and 2013, off-balance sheet exposure primarily consisting of commitments to real estate and investment entities was $56.4 million and $50.8 million, respectively.
* At December 31, 2014 and 2013, $3.2 billion and $2.8 billion, respectively, of our total unconsolidated VIE assets were recorded as Other invested assets.
We use derivatives and other financial instruments as part of our financial risk management programs and as part of our investment operations. Interest rate, currency, equity and commodity swaps, credit contracts (including the super senior credit default swap portfolio), swaptions, options and forward transactions are accounted for as derivatives, recorded on a trade-date basis and carried at fair value. Unrealized gains and losses are reflected in income, when appropriate. In certain instances, a contract’s transaction price is the best indication of initial fair value. Aggregate asset or liability positions are netted on the Consolidated Balance Sheets only to the extent permitted by qualifying master netting arrangements in place with each respective counterparty. Cash collateral posted with counterparties in conjunction with transactions supported by qualifying master netting arrangements is reported as a reduction of the corresponding net derivative liability, while cash collateral received in conjunction with transactions supported by qualifying master netting arrangements is reported as a reduction of the corresponding net derivative asset.
Effective April 1, 2014, we reclassified cross-currency swaps from Interest rate contracts to Foreign exchange contracts. This change was applied prospectively.
The following table presents the notional amounts and fair values of our derivative instruments:
(c) Represents cash collateral posted and received that is eligible for netting.
Collateral posted by us to third parties for derivative transactions was $3.3 billion and $3.2 billion at December 31, 2014 and 2013, respectively. In the case of collateral posted under derivative transactions that are not subject to clearing, this collateral can generally be repledged or resold by the counterparties. Collateral provided to us from third parties for derivative transactions was $1.3 billion and $1.0 billion at December 31, 2014 and 2013, respectively. We generally can repledge or resell collateral posted under derivative transactions that are not subject to clearing.
We have elected to present all derivative receivables and derivative payables, and the related cash collateral received and paid, on a net basis on our Consolidated Balance Sheets when a legally enforceable ISDA Master Agreement exists between us and our derivative counterparty. An ISDA Master Agreement is an agreement between two counterparties, which may have multiple derivative transactions with each other governed by such agreement, and such ISDA Master Agreement generally provides for the net settlement of all or a specified group of these derivative transactions, as well as pledged collateral, through
a single payment, in a single currency, in the event of a default on, or affecting any, one derivative transaction or a termination event affecting all, or a specified group of, derivative transactions.
The following table presents the effect of our derivative instruments in cash flow hedging relationships in the Consolidated Statements of Income:
(b) Includes $19 million for the year ended December 2012, representing the reclassification from Accumulated other comprehensive income into earnings following the discontinuation of cash flow hedges of ILFC debt.
(b) Includes embedded derivative gains (losses) of $(837) million, $1.2 billion and $(170) million for the years ended December 31, 2014, 2013 and 2012, respectively.
Credit default swap transactions were entered into by AIGFP with the intention of earning revenue on credit exposure. In the majority of these transactions, we sold credit protection on a designated portfolio of loans or debt securities. Generally, such credit protection was provided on a “second loss” basis, meaning we would incur credit losses only after a shortfall of principal and/or interest, or other credit events, in respect of the protected loans and debt securities, exceeded a specified threshold amount or level of “first losses.”
(b) Corporate debt/Collateralized Loan Obligations (CLOs) include $555 million and $1.0 billion in net notional amount of credit default swaps written on the super senior tranches of CLOs at December 31, 2014 and 2013, respectively. Collateral postings with regards to corporate debt/CLOs were $147 million and $353 million at December 31, 2014 and 2013, respectively.
(c) On July 17, 2014, AIGFP terminated Corporate Debt Super Senior CDSs with a notional amount of $8.8 billion.
The expected weighted average maturity of the super senior credit derivative portfolios as of December 31, 2014 was five years for the multi-sector CDO arbitrage portfolio and three years for the corporate debt/CLO portfolio.
We have legacy credit default swap contracts referencing single-name exposures written on corporate, index and asset-backed credits with the intention of earning spread income on credit exposure. Some of these transactions were entered into as part of a long-short strategy to earn the net spread between CDSs written and purchased. At December 31, 2014 and 2013, the net notional amounts of these written CDS contracts were $190 million and $373 million, respectively, including ABS CDS transactions purchased from a liquidated multi-sector super senior CDS transaction. These exposures were partially hedged by purchasing offsetting CDS contracts of $5 million and $50 million in net notional amounts at December 31, 2014 and 2013, respectively. The net unhedged positions of $185 million and $323 million at December 31, 2014 and 2013, respectively, represent the maximum exposure to loss on these CDS contracts. The average maturity of the written CDS contracts was two years and three years at December 31, 2014 and 2013, respectively. At December 31, 2014 and 2013, the fair values of derivative liabilities (which represents the carrying amount) of the portfolio of CDS was $25 million and $32 million, respectively.
The aggregate fair value of our derivative instruments that contain credit risk-related contingent features that were in a net liability position at December 31, 2014 and 2013, was approximately $2.5 billion and $2.6 billion, respectively. The aggregate fair value of assets posted as collateral under these contracts at December 31, 2014 and 2013, was $2.7 billion and $3.1 billion, respectively.
We invest in hybrid securities (such as credit-linked notes) with the intent of generating income, and not specifically to acquire exposure to embedded derivative risk. As is the case with our other investments in RMBS, CMBS, CDOs and ABS, our
Goodwill represents the future economic benefits arising from assets acquired in a business combination that are not individually identified and separately recognized. Goodwill is tested for impairment annually or more frequently if circumstances indicate an impairment may have occurred. We assess goodwill for impairment at one level below our reportable segments. At December 31, 2014, in consideration of the 2014 segment changes, our reporting units with goodwill are Commercial Insurance - Property Casualty, Consumer Insurance - Personal Insurance, and Consumer Insurance - Life. When a business is transferred from one reporting unit to another, as occurred with the transfer of a portion of the Consumer Insurance - Personal Insurance to Consumer Insurance - Life, as part of the 2014 segment changes, goodwill at the original reporting unit is allocated among reporting units based on the fair value of business transferred, relative to business retained by a reporting unit.
Goodwill was not impaired at December 31, 2014 based on the results of the goodwill impairment test.
(a) For the 2012 amounts, $847 million was reclassified from "Foreign exchange effect" to "Losses and loss adjustment expenses paid (current year)". The impact of this reclassification was a decrease of $847 million for foreign exchange and loss expenses paid (current year), with no income statement or balance sheet impact.
(b) In 2014, included $545 million, $381 million, $(195) million, $135 million and $109 million related to primary casualty, environmental and asbestos, natural catastrophes, financial lines and healthcare, respectively. In 2013, included $(144) million, $269 million, $498 million and $(54) million related to excess casualty, environmental and pollution, primary casualty and healthcare, respectively. In 2012, includes $157 million, $200 million, $531 million and $68 million related to excess casualty, environmental and pollution, primary casualty and healthcare, respectively.
• Certain asbestos business that was written by Non-Life Insurance Companies is discounted, when allowed by the regulator and when payments are fixed and determinable, based on the investment yields of the companies and the payout pattern for this business.
• The tabular workers’ compensation discount is calculated based on a 3.5 percent interest rate and the 1999 U.S. Decennial Life Table.
• In the fourth quarter of 2014, 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.
For universal life policies with secondary guarantees, we recognize a future policy benefit reserve, in addition to policyholder contract deposits, based on a benefit ratio of (a) the present value of total expected payments, in excess of the account value, over the life of the contract, divided by (b) the present value of total expected assessments over the life of the contract. For universal life policies without secondary guarantees, for which profits followed by losses are first expected after contract inception, we establish future policy benefit reserves, in addition to policyholder contract deposits, so that expected future losses are recognized in proportion to the emergence of profits in the earlier (profitable) years.
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 0.3% to 8.4% at December 31, 2014, 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.
Other policyholder funds include unearned revenue reserves (URR). URR consists of front-end loads on investment-oriented contracts, representing those policy loads that are non-level and typically higher in initial policy years than in later policy years. URR for investment-oriented contracts are generally deferred and amortized, with interest, in relation to the incidence of estimated gross profits (EGPs) to be realized over the estimated lives of the contracts and are subject to the same adjustments due to changes in the assumptions underlying EGPs as DAC. Amortization of URR is recorded in Policy Fees.
Other policyholder funds also include provisions for future dividends to participating policyholders, accrued in accordance with all applicable regulatory or contractual provisions. Participating life business represented approximately 1.9 percent of the gross insurance in force at December 31, 2014 and 3.7 percent of gross Premiums and other considerations in 2014. The amount of annual dividends to be paid is approved locally by the boards of directors of the insurance companies. Provisions for future dividend payments are computed by jurisdiction, reflecting local regulations. The portions of current and prior net income and of current unrealized appreciation of investments that can inure to our benefit are restricted in some cases by the insurance contracts and by the local insurance regulations of the jurisdictions in which the policies are in force.