Under the fair value option, we may elect to measure at fair value financial assets and financial liabilities that are not otherwise required to be carried at fair value. Subsequent changes in fair value for designated items are reported in earnings. We elect the fair value option for certain hybrid securities given the complexity of bifurcating the economic components associated with the embedded derivatives. Refer to Note 12 for additional information related to embedded derivatives.
Additionally, beginning in the third quarter of 2012 we elected the fair value option for investments in certain private equity funds, hedge funds and other alternative investments when such investments are eligible for this election. We believe this measurement basis is consistent with the applicable accounting guidance used by the respective investment company funds themselves. Refer to Note 7 herein for additional information.
(b) Excludes discontinued operation gains or losses on instruments that were required to be carried at fair value. For instruments required to be carried at fair value, we recognized gains of $586 million, $1.3 billion and $4.9 billion for the years ended 2012, 2011 and 2010, respectively, that were primarily due to changes in the fair value of derivatives, trading securities and certain other invested assets for which the fair value option was not elected.
Interest income and dividend income on assets elected under the fair value option are recognized and included in Net Investment Income in the Consolidated Statement of Operations with the exception of DIB-related activity, which is included in Other income. Interest on liabilities for which we elected the fair value option is recognized in interest expense in the Consolidated Statement of Operations. See Note 7 herein for additional information about our policies for recognition, measurement, and disclosure of interest and dividend income and interest expense.
Mortgage and other loans receivable: Fair values of loans on real estate and other loans receivable were estimated for disclosure purposes using discounted cash flow calculations based upon discount rates that we believe market participants would use in determining the price that they would pay for such assets. For certain loans, our current incremental lending rates for similar types of loans is used as the discount rate, as we believe that this rate approximates the rates that market participants would use. The fair values of policy loans are generally estimated based on unpaid principal amount as of each reporting date or, in some cases, based on the present value of the loans using a discounted cash flow model. No consideration is given to credit risk as policy loans are effectively collateralized by the cash surrender value of the policies.
Other Invested Assets: The majority of Other invested assets that are not measured at fair value represent investments in life settlement contracts. The fair value of life settlement contracts included in Other invested assets is determined on a discounted cash flow basis, incorporating current life expectancy assumptions.
Cash and short-term investments: The carrying values of these assets approximate fair values because of the relatively short period of time between origination and expected realization, and their limited exposure to credit risk.
Fixed maturity and equity securities classified as available for sale or as trading are carried at fair value. Unrealized gains and losses from available for sale investments in fixed maturity and equity securities are reported as a separate component of Accumulated other comprehensive income (loss), net of deferred acquisition costs and deferred income taxes, in Total AIG shareholders' equity. Realized and unrealized gains and losses from fixed maturity and equity securities classified as trading are reflected in Net investment income (for insurance subsidiaries) or Other income (for DIB). Investments in fixed maturity and equity securities are recorded on a trade-date basis.
Trading securities include the investment portfolio of the DIB. Trading securities for the DIB are held to meet short-term investment objectives and to economically hedge other securities.
(b) At December 31, 2012 and December 31, 2011, bonds available for sale held by us that were below investment grade or not rated totaled $29.6 billion and $24.2 billion, respectively.
The following table presents the gross realized gains and gross realized losses from sales or redemptions of our available for sale securities:
The following table presents the fair value of our trading securities:
(b) Net of accumulated depreciation of $469 million and $428 million in 2012 and 2011, respectively.
Summarized financial information for AIA was as of and for the year ended 2011. AIA was consolidated through October 28, 2010. As a result, comparable amounts for 2010 are not being presented.
The following is the aggregated summarized financial information of our other equity method investees, including those for which the fair value option has been elected:
During 2012, 2011 and 2010, income recognized on life settlement contracts was $253 million, $320 million and $213 million, respectively, and is included in Net investment income in the Consolidated Statement of Operations. Our life settlement contracts reported above are monitored for impairment on a contract-by-contract basis quarterly. Impairment charges on life settlement contracts included in net realized capital gains (losses) totaled $309 million, $312 million and $74 million in 2012, 2011, and 2010 respectively.
At December 31, 2012, the anticipated life insurance premiums required to keep the life settlement contracts in force, payable in the next 12 months ending December 31, 2013 and the four succeeding years ending December 31, 2017 are $546 million, $555 million, $562 million, $554 million and $555 million, respectively.
* Includes hedge funds, private equity funds, affordable housing partnerships and other investment partnerships.
•Sales of fixed maturity securities and equity securities (except trading securities accounted for at fair value and investments for which the fair value option has been elected), real estate, investments in private equity funds and hedge funds and other types of investments.
•Reductions to the cost basis of fixed maturity securities and equity securities (except trading securities accounted for at fair value and investments for which the fair value option has been elected) and other invested assets for other-than-temporary impairments.
For all other fixed maturity securities for which a credit impairment has occurred, the amortized cost is written down to the estimated recovery value with a corresponding charge to earnings. The estimated recovery value is the present value of cash flows expected to be collected, as determined by management. The difference between fair value and amortized cost that is not related to a credit impairment is recognized in unrealized appreciation (depreciation) of fixed maturity securities on which other-than-temporary credit impairments were taken (a separate component of Accumulated other comprehensive income (loss)).
* Represents accretion recognized due to changes in cash flows expected to be collected over the remaining expected term of the credit impaired securities as well as the accretion due to the passage of time.
Our investments in aircraft assets and real estate are periodically evaluated for recoverability whenever changes in circumstances indicate the carrying amount of an asset may be impaired. When impairment indicators are present, we compare expected investment cash flows to carrying value. When the expected cash flows are less than the carrying value, the investments are written down to fair value with a corresponding charge to earnings.
In 2011, we began purchasing certain RMBS securities that had experienced deterioration in credit quality since their issuance. We determined, based on our expectations as to the timing and amount of cash flows expected to be received, that it was probable at acquisition that we would not collect all contractually required payments for these PCI securities, including both principal and interest after considering the effects of prepayments. At acquisition, the timing and amount of the undiscounted future cash flows expected to be received on each PCI security was determined based on our best estimate using key assumptions, such as interest rates, default rates and prepayment speeds. At acquisition, the difference between the undiscounted expected future cash flows of the PCI securities and the recorded investment in the securities represents the initial accretable yield, which is to be accreted into net investment income over their remaining lives on a level-yield basis. Additionally, the difference between the contractually required payments on the PCI securities and the undiscounted expected future cash flows represents the non-accretable difference at acquisition. Over time, based on actual payments received and changes in estimates of undiscounted expected future cash flows, the accretable yield and the non-accretable difference can change, as discussed further below.
Total carrying values of cash and securities deposited by our insurance subsidiaries under requirements of regulatory authorities or other insurance-related arrangements, including certain annuity-related obligations and certain reinsurance agreements, were $8.9 billion and $9.8 billion at December 31, 2012 and 2011, respectively.
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 $4.4 billion and $5.1 billion at December 31, 2012 and December 31, 2011, 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.
* Commercial mortgages primarily represent loans for office, retail and industrial properties, with exposures in California and New York representing the largest geographic concentrations (22 percent and 15 percent, respectively, at December 31, 2012). Over 99 percent and 98 percent of the commercial mortgages were current as to payments of principal and interest at December 31, 2012 and 2011, respectively.
(a) Of the total, $47 million and $65 million relates to individually assessed credit losses on $286 million and $476 million of commercial mortgage loans as of December 31, 2012 and 2011, respectively.
(b) Included in Other loans were finance receivables, which were reported net of unearned finance charges, for both investment purposes and held for sale.
As of December 31, 2012 and 2011, we held no significant loans that had been modified in a TDR during those respective years.
Short-duration reinsurance is effected under reinsurance treaties and by negotiation on individual risks. Certain of these reinsurance arrangements consist of excess of loss contracts that protect us against losses above stipulated amounts. Ceded premiums are considered prepaid reinsurance premiums and are recognized as a reduction of premiums earned over the contract period in proportion to the protection received. Amounts recoverable from reinsurers on short-duration contracts are estimated in a manner consistent with the claims liabilities associated with the reinsurance and presented as a component of Reinsurance assets. Assumed reinsurance premiums are earned primarily on a pro-rata basis over the terms of the reinsurance contracts and the portion of premiums relating to the unexpired terms of coverage is included in the reserve for unearned premiums. For both ceded and assumed reinsurance, risk transfer requirements must be met for reinsurance accounting to apply. If risk transfer requirements are not met, the contract is accounted for as a deposit, resulting in the recognition of cash flows under the contract through a deposit asset or liability and not as revenue or expense. To meet risk transfer requirements, a reinsurance contract must include both insurance risk, consisting of both underwriting and timing risk, and a reasonable possibility of a significant loss for the assuming entity. Similar risk transfer criteria are used to determine whether directly written insurance contracts should be accounted for as insurance or as a deposit.
For the years ended December 31, 2012, 2011 and 2010, reinsurance recoveries, which reduced loss and loss expenses incurred, amounted to $4.5 billion, $6.1 billion and $8.0 billion, respectively.
* Primarily represents results of AIA, which was deconsolidated during 2010.
Long-duration reinsurance recoveries, which reduced death and other benefits, approximated $758 million, $611 million and $810 million, respectively, for the years ended December 31, 2012, 2011 and 2010.
AIG Life and Retirement operations utilize internal and third-party reinsurance relationships to manage insurance risks and to facilitate capital management strategies. As a result of these reinsurance arrangements AIG Life and Retirement is able 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. AIG Life and Retirement's domestic long-duration insurance companies also cede excess, non-economic reserves carried on a
AIG Life and Retirement generally obtains letters of credit to obtain statutory recognition of its intercompany reinsurance transactions, particularly with respect to redundant statutory reserves requirements on term insurance and universal life with secondary guarantees (XXX and AXXX reserves). For this purpose, AIG Life and Retirement has a $585 million syndicated letter of credit facility outstanding at December 31, 2012, all of which relates to long-duration intercompany reinsurance transactions. AIG Life and Retirement has also obtained approximately $215 million of letters of credit on a bilateral basis all of which relates to long-duration intercompany reinsurance transactions. All of these approximately $800 million of letters of credit are due to mature on December 31, 2015.
Deferred policy acquisition costs represent those costs that are incremental and directly related to the successful acquisition of new or renewal of existing insurance contracts. We defer incremental costs that result directly from, and are essential to, the acquisition or renewal of an insurance contract. Such deferred policy acquisition costs generally include agent or broker commissions and bonuses, premium taxes, and medical and inspection fees that would not have been incurred if the insurance contract had not been acquired or renewed. Each cost is analyzed to assess whether it is fully deferrable. We partially defer costs, including certain commissions, when we do not believe that the entire cost is directly related to the acquisition or renewal of insurance contracts.
Advertising costs related to the issuance of insurance contracts that meet the direct-advertising criteria are deferred and amortized as part of DAC.
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. Policy acquisition costs and policy issuance costs related to universal life, and investment-type products (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 are composed of net investment income, net realized investment gains and losses, fees, surrender charges, expenses, and mortality and morbidity gains and losses.
We use a "reversion to the mean" methodology, which allows us to maintain our long-term assumptions, while also giving consideration to the effect of deviations from these assumptions occurring in the current period. A DAC unlocking is performed when management determines that key assumptions (e.g. market return, surrender rates, etc.) should be modified. The DAC asset is recalculated using the new assumptions. The use of a reversion to the mean assumption is common within the industry; however, the parameters used in the methodology are subject to judgment and vary within the industry. If estimated gross profits change significantly, DAC is recalculated using the new assumptions. Any resulting adjustment is included in income as an adjustment to DAC. 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.
The DAC for investment-oriented products is also adjusted for changes in estimated gross profits that result from changes in the net unrealized gains or losses on fixed maturity and equity securities available for sale. Because fixed maturity and equity securities available for sale are carried at aggregate fair value, an adjustment is made to DAC equal to the change in DAC amortization that would have been recorded if such securities had been sold at their stated aggregate fair value and the proceeds reinvested at current yields. For long-duration traditional business, if such reinvestment would not be sufficient to recover DAC and meet policyholder obligations an adjustment to DAC and additional future policy benefits for those products is recorded using current best estimates that incorporate a review of assumptions regarding mortality, morbidity, persistency, maintenance expenses and investment returns.
The change in these adjustments, net of tax, is included with the change in net unrealized appreciation (depreciation) of investments that is credited or charged directly to Accumulated other comprehensive income (loss) (Shadow DAC).
(a) Includes $(619) million, $(1.4) billion, and $(758) million for AIG Life and Retirement at December 31, 2012, 2011 and 2010, respectively, and $(34) million for Divested businesses at 2011 related to the effect of net unrealized gains and losses on available for sale securities. For the year ended December 31, 2010, there were no net unrealized gains and losses on available for sale securities associated with divested businesses.
While we enter into various arrangements with VIEs in the normal course of business, our involvement with VIEs is primarily via our insurance companies as a passive investor in debt securities (rated and unrated) and equity interests issued by VIEs. In all instances, we consolidate the VIE when we determine we are the primary beneficiary. This analysis includes a review of the VIE's capital structure, contractual relationships and terms, nature of the VIE's operations and purpose, nature of the VIE's interests issued and our involvement with the entity. When assessing the need to consolidate a VIE, we evaluate the design of the VIE as well as the related risks the entity was designed to expose the variable interest holders to.
The following table presents our total assets, total liabilities and off-balance sheet exposure associated with our variable interests in consolidated VIEs:
(b) Decrease primarily due to the retirement of the AIA SPV Preferred Interests held by the Department of the Treasury. As a result, the AIA SPV no longer qualified as a VIE. Assets include $567 million of cash held in escrow pursuant to the terms of the ALICO stock purchase agreement between AIG and MetLife. See Note 16 herein for further discussion of the escrow arrangement.
(c) At December 31, 2012 and December 31, 2011, off-balance sheet exposure with respect to real estate and investments funds was $48.7 million and $85.7 million, respectively.
We calculate our maximum exposure to loss to be (i) the amount invested in the debt or equity of the VIE, (ii) the notional amount of VIE assets or liabilities where we have also provided credit protection to the VIE with the VIE as the referenced obligation, and (iii) other commitments and guarantees to the VIE. Interest holders in VIEs sponsored by us generally have recourse only to the assets and cash flows of the VIEs and do not have recourse to us, except in limited circumstances when we have provided a guarantee to the VIE's interest holders.
Our interests in the assets and liabilities of consolidated and unconsolidated VIEs were classified in the Consolidated Balance Sheet as follows:
* Decrease from prior year was due to the repayment of the FRBNY Credit Facility from the AIA and ALICO SPVs pursuant to the Recapitalization.
AIG, through AIG Global Real Estate, is an investor in various real estate investments, some of which are VIEs. These investments are typically with unaffiliated third-party developers via a partnership or limited liability company structure. The VIE's activities consist of the development or redevelopment of commercial and residential real estate. Our involvement varies from being a passive equity investor or finance provider to actively managing the activities of the VIE.
Our insurance operations participate as passive investors in the equity issued primarily by third-party-managed hedge and private equity funds. Our insurance operations typically are not involved in the design or establishment of VIEs, nor do they actively participate in the management of VIEs.
Through the DIB, we sponsor Nightingale Finance Ltd, a structured investment vehicle (SIV), which meets the definition of a VIE. Nightingale Finance Ltd. invests in variable rate, investment-grade debt securities, the majority of which are ABS. We have no equity interest in the SIV, but we maintain the power to direct the activities of the SIV that most significantly impact the entity's economic performance and bear the obligation to absorb economic losses that could potentially be significant to the SIV. We are the primary beneficiary and consolidate the assets of the SIV, which totaled over $1.7 billion as of December 31, 2012. Related liabilities were not significant.
In 2008, AIG entered into an agreement with the FRBNY, ML III and The Bank of New York Mellon, which established arrangements, through ML III, to fund the purchase of multi-sector CDOs underlying or related to CDS written by AIGFP. Concurrently, AIGFP's counterparties to such CDS transactions agreed to terminate those CDS transactions relating to the multi-sector CDOs purchased from them. AIG had a significant variable interest in ML III, which was a VIE. In 2012, we received final distributions from ML II and ML III.
We sponsor one VIE that has issued a variable funding note backed by a commercial loan collateralized by individual life insurance assets. As of December 31, 2012, total consolidated assets and liabilities for this entity were $412 million and $188 million, respectively; our maximum exposure, representing the carrying value of the consumer loan, was $389 million.
Through our insurance company subsidiaries, we are a passive investor in RMBS, CMBS, other ABS and CDOs primarily issued by domestic special-purpose entities. We generally do not sponsor or transfer assets to, or act as the servicer to these asset-backed structures, and were not involved in the design of these entities.
ILFC has created wholly-owned subsidiaries for the purpose of purchasing aircraft and obtaining financing secured by such aircraft. A portion of the secured debt has been guaranteed by the European Export Credit Agencies and the Export-Import Bank of the United States. These entities meet the definition of a VIE because they do not have sufficient equity to operate without ILFC's subordinated financial support in the form of intercompany notes which serve as equity. ILFC fully consolidates the entities, controls all the activities of the entities and guarantees the activities of the entities. AIG has not included these entities in the above table as they are wholly-owned and there are no other variable interests other than those of ILFC and the lenders. See Note 15 herein for further information.
Derivatives, with the exception of bifurcated embedded derivatives, are reflected in the Consolidated Balance Sheet in Derivative assets, at fair value and Derivative liabilities, at fair value. A bifurcated embedded derivative is measured at fair value and accounted for in the same manner as a free standing derivative contract. The corresponding host contract is accounted for according to the accounting guidance applicable for that instrument. A bifurcated embedded derivative is generally presented with the host contract in the Consolidated Balance Sheet. See Note 6 herein for additional information on embedded policy derivatives.
The following table presents the fair values of derivative assets and liabilities in the Consolidated Balance Sheet:
Collateral posted by us to third parties for derivative transactions was $4.5 billion and $4.7 billion at December 31, 2012 and December 31, 2011, respectively. This collateral can generally be repledged or resold by the counterparties. Collateral obtained by us from third parties for derivative transactions was $1.4 billion and $1.6 billion at December 31, 2012 and December 31, 2011, respectively. We generally can repledge or resell this collateral.
We use foreign currency denominated debt and cross-currency swaps as hedging instruments in net investment hedge relationships to mitigate the foreign exchange risk associated with our non-U.S. dollar functional currency foreign subsidiaries. We assess the hedge effectiveness and measure the amount of ineffectiveness for these hedge relationships based on changes in spot exchange rates. For the years ended December 31, 2012, 2011, and 2010 we recognized gains (losses) of $(74) million, $(13) million and $28 million, respectively, included in Foreign currency translation adjustment in Accumulated other comprehensive income related to the net investment hedge relationships.
(a) Gains and losses recognized in earnings for the ineffective portion and amounts excluded from effectiveness testing, if any, are recorded in Net realized capital gains (losses).
(b) Includes $124 million and $149 million, for the years ended December 31, 2012 and 2011, respectively, representing the amortization of debt basis adjustment recorded in Other income and Net realized capital gains (losses) following the discontinuation of hedge accounting.
The following table presents the effect of our derivative instruments in cash flow hedging relationships in the Consolidated Statement of Operations:
(a) Hedge accounting was discontinued in December 2012 subsequent to the announcement of the ILFC Transaction. Gains and losses recognized in earnings are recorded in Income (loss) from discontinued operations. Previously the effective portion of the change in fair value of a derivative qualifying as a cash flow hedge was recorded in Accumulated other comprehensive income until earnings were affected by the variability of cash flows in the hedged item. Gains and losses reclassified from Accumulated other comprehensive income were previously recorded in Other income. Gains or losses recognized in earnings on derivatives for the ineffective portion were previously recorded in Net realized capital gains (losses).
(b) Includes embedded derivative losses of $166 million and $397 million for the years ended December 31, 2012 and 2011, respectively.
(a) Net notional amounts presented are net of all structural subordination below the covered tranches. The decrease in the total net notional amount from December 31, 2011 to December 31, 2012 was due primarily to terminations of $5.4 billion and amortization of $3.2 billion.
(e) Corporate debt/CLOs include $1.2 billion in net notional amount of credit default swaps written on the super senior tranches of CLOs at both December 31, 2012 and December 31, 2011. Collateral postings with regards to corporate debt/CLOs were $420 million and $477 million at December 31, 2012 and December 31, 2011, respectively.
Given the current performance of the underlying portfolios, the level of subordination of the credit protection written and the assessment of the credit quality of the underlying portfolio, as well as the risk mitigants inherent in the transaction structures, we do not expect that we will be required to make payments pursuant to the contractual terms of those transactions providing regulatory relief.
Because of long-term maturities of the CDS in the arbitrage portfolio, we are unable to make reasonable estimates of the periods during which any payments would be made. However, the net notional amount represents the maximum exposure to loss on the super senior credit default swap portfolio.
We have also entered into 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 CDS written and purchased. At December 31, 2012, the net notional amount of these written CDS contracts was $410 million, including ABS CDS transactions purchased from a liquidated multi-sector super senior CDS transaction. These exposures have been partially hedged by purchasing offsetting CDS contracts of $51 million in net notional amount. The net unhedged position of $359 million represents the maximum exposure to loss on these CDS contracts. The average maturity of the written CDS contracts is 4 years. At December 31, 2012, the fair value of derivative liability (which represents the carrying value) of the portfolio of CDS was $48 million.
These CDS contracts were written under ISDA Master Agreements. The majority of these ISDA Master Agreements include credit support annexes (CSAs) that provide for collateral postings at various ratings and threshold levels. At December 31, 2012, collateral posted by us under these contracts was $64 million prior to offsets for other transactions.
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, 2012, was approximately $3.9 billion. The aggregate fair value of assets posted as collateral under these contracts at December 31, 2012, was 4.3 billion.
We estimate that at December 31, 2012, based on our outstanding financial derivative transactions a one-notch downgrade of our long-term senior debt ratings to BBB+ by Standard & Poor's Financial Services LLC, a subsidiary of The McGraw-Hill Companies, Inc. (S&P), would permit counterparties to make additional collateral calls and permit certain counterparties to elect early termination of contracts, resulting in a negligible amount of corresponding collateral postings and termination payments; a one-notch downgrade to Baa2 by Moody's Investors' Service, Inc. (Moody's) and an additional one-notch downgrade to BBB by S&P would result in approximately $102 million in additional collateral postings and termination payments and a further one-notch downgrade to Baa3 by Moody's and BBB- by S&P would result in approximately $112 million in additional collateral postings and termination payments. Additional collateral postings upon downgrade are estimated based on the factors in the individual collateral posting provisions of the CSA with each counterparty and current exposure as of December 31, 2012. Factors considered in estimating the termination payments upon downgrade include current market conditions, the complexity of the derivative transactions, historical termination experience and other observable market events such as bankruptcy and downgrade events that have occurred at other companies. Our estimates are also based on the assumption that counterparties will terminate based on their net exposure to us. The actual termination payments could significantly differ from our estimates given market conditions at the time of downgrade and the level of uncertainty in estimating both the number of counterparties who may elect to exercise their right to terminate and the payment that may be triggered in connection with any such exercise.
13. LIABILITY FOR UNPAID CLAIMS AND CLAIMS ADJUSTMENT EXPENSE AND FUTURE POLICY BENEFITS FOR LIFE AND ACCIDENT AND HEALTH INSURANCE CONTRACTS AND POLICYHOLDER CONTRACT DEPOSITS
The following table presents the reconciliation of activity in the Liability for unpaid claims and claims adjustment expense:
the case of asbestos, since 1985, standard policies have contained an absolute exclusion for asbestos and pollution-related damages. The factors driving excess casualty loss cost were primarily due to medical inflation and the exhaustion of underlying primary policies for products liability coverage and for homebuilders. In 2010, excess workers' compensation also experienced significant prior year development related to the passage of the Affordable Care Act in March 2010 as we concluded that there is increased vulnerability to the risk of further cost-shifting to the excess workers' compensation class of business.
At December 31, 2012, the liability for unpaid claims and claims adjustment expense reflects a net loss reserve discount of $3.2 billion, including tabular and non-tabular calculations based upon the following assumptions:
•The non-tabular workers' compensation discount is calculated separately for companies domiciled in New York and Pennsylvania, and follows the statutory regulations for each state. For New York companies, the discount is based on a five percent interest rate and the companies' own payout patterns. For Pennsylvania companies, the statute has specified discount factors for accident years 2001 and prior, which are based on a six percent interest rate and an industry payout pattern. For accident years 2002 and subsequent, the discount is based on the payout patterns and investment yields of the companies.
Future policy benefits for life and accident and health insurance contracts include provisions for future dividends to participating policyholders, accrued in accordance with all applicable regulatory or contractual provisions. Also included in Future policy benefits are liabilities for annuities issued in structured settlement arrangements whereby a claimant has agreed to settle a general insurance claim in exchange for fixed payments over a fixed determinable period of time with a life contingency feature. Structured settlement liabilities are presented on a discounted basis because the settled claims are fixed and determinable. Policyholder contract deposits also include our liability for (a) certain guarantee benefits accounted for as embedded derivatives at fair value, (b) annuities issued in a structured settlement arrangement with no life contingency and (c) certain contracts we elected to account for at fair value.
Long duration contract liabilities included in future policy benefits, as presented in the preceding table, result primarily from life products. Short duration contract liabilities are primarily accident and health products. The liability for future life policy benefits has been established on the basis of the following assumptions:
•Interest rates credited on deferred annuities, which vary by year of issuance, range from 1 percent to, including bonuses, 9 percent. Current declared interest rates are generally guaranteed to remain in effect for a period of one year though some are guaranteed for longer periods. Withdrawal charges generally range from zero percent to 20 percent grading to zero over a period of zero to 15 years.
•Interest rates on corporate life insurance products are guaranteed at 3 percent and the weighted average rate credited in 2012 was 4.6 percent.
The GMDB liability is determined each period end by estimating the expected value of death benefits in excess of the projected account balance and recognizing the excess ratably over the accumulation period based on total expected assessments. We regularly evaluate estimates used and adjust the additional liability balance, with a
The following assumptions and methodology were used to determine the GMDB liability at December 31, 2012:
•Mean investment performance assumptions ranged from three percent to approximately ten percent depending on the block of business.
•The discount rate ranged from 3.75 percent to 10 percent and is based on the growth rate assumption for the underlying contracts in effect at the time of policy issuance. In addition to GMDB, our contracts currently include to a lesser extent GMIB. The GMIB liability is determined each period end by estimating the expected value of the annuitization benefits in excess of the projected account balance at the date of annuitization and recognizing the excess ratably over the accumulation period based on total expected assessments. We periodically evaluate estimates used and adjust the additional liability balance, with a related charge or credit to benefit expense, if actual experience or other evidence suggests that earlier assumptions should be revised.
(a) We may currently redeem our 6.45% Series A-4 and our 7.7% Series A-5 junior subordinated debt at their respective principal amounts plus unpaid accrued interest on any of their respective interest payment dates. The remaining junior subordinated debt is subject to call options that range from 2017-2038 and if we do not exercise these call options, the interest rate will change from the referenced fixed interest rate to a floating rate. See further discussion under Junior Subordinated Debt below.
(c) Excludes $24.3 billion of debt for ILFC at December 31, 2012 which has been reclassified to Liabilities of businesses held for sale.
(d) At December 31, 2012 and 2011, includes debt of consolidated investments held through AIG Global Real Estate Investment Corp., AIG Credit Corp. and SunAmerica of $1.5 billion, $176 million and $133 million and $1.5 billion, $233 million and $91 million, respectively.
amount of our outstanding Series A-3 Junior Subordinated Debentures for €421 million ($545 million at the December 31, 2011 exchange rate) aggregate principal amount of our new 6.797% Euro notes due November 15, 2017. This exchange resulted in a pre-tax gain on extinguishment of debt of approximately $484 million, which is reflected in Net loss on extinguishment of debt in the Consolidated Statement of Operations and a deferred gain of $65 million, which will be amortized as a reduction to future interest expense.
We may currently redeem our 6.45% Series A-4 Junior Subordinated Debentures and our 7.70% Series A-5 Junior Subordinated Debentures, in whole or in part, at their respective principal amounts plus accrued and unpaid interest through the date of redemption.
In connection with our acquisition of SunAmerica Financial Group, Inc. (SAFG, Inc.) in 2001, we entered into arrangements with SAFG, Inc. with respect to outstanding SAFG, Inc. capital securities. In 1996, SAFG, Inc. issued capital securities through a trust to institutional investors and funded the trust with SAFG, Inc. junior subordinated debentures issued to the trust. SAFG, Inc. guaranteed payments to the holders of capital securities only to the extent (i) the trust received payments on the debentures and (ii) these payments were available for the trust to pay to holders of capital securities. In 2001, AIG Parent guaranteed the same payments to the holders of capital securities. Like the SAFG, Inc. guarantee, the AIG Parent guarantee only applies to any payments actually made to the trust in respect of the debentures. If no payments are made on the debentures, AIG Parent is not required to make any payments to the trust. AIG Parent also guaranteed the debentures pursuant to a guarantee that is expressly subordinated to certain SAFG, Inc. senior debt securities. Under the AIG Parent guarantee, AIG Parent is not required to make any payments in respect of the debentures if such payment would be prohibited by the subordination provisions of the debentures. As a result, AIG Parent will never be required to make a payment under its guarantee of the debentures for so long as SAFG, Inc. is prohibited from making a payment on the debentures.
AIG recorded an increase in its estimated litigation liability of approximately $783 million for the year ended December 31, 2012 based on developments in several actions.
On April 1, 2011, the lead plaintiff in the Consolidated 2008 Securities Litigation filed a motion to certify a class of plaintiffs. On November 2, 2011, the Court terminated the motion without prejudice to an application for restoration. On March 30, 2012, the lead plaintiff filed a renewed motion to certify a class of plaintiffs.
As of February 21, 2013, plaintiffs have not formally specified an amount of alleged damages, discovery is ongoing, and the Court has not determined if a class action is appropriate or the size or scope of any class. As a result, we are unable to reasonably estimate the possible loss or range of losses, if any, arising from the litigation.
In plaintiff's proposed statement of claim, plaintiff alleged general and special damages of $500 million and punitive damages of $50 million plus prejudgment interest or such other sums as the Court finds appropriate. As of February 21, 2013 the Court has not determined whether it has jurisdiction or granted plaintiff's application to file a statement of claim, no merits discovery has occurred and the action has been stayed. As a result, we are unable to reasonably estimate the possible loss or range of losses, if any, arising from the litigation.
On November 21, 2011, SICO also filed a second complaint in the Southern District of New York against the FRBNY bringing claims, both individually and on behalf of all others similarly situated and derivatively on behalf of AIG (the SICO New York Action). This complaint also challenges the government's assistance of AIG, pursuant to which AIG entered into the FRBNY Credit Facility and the United States received an approximately 80 percent ownership in AIG. The complaint alleges that the FRBNY owed fiduciary duties to AIG as our controlling shareholder, and that the FRBNY breached these fiduciary duties by "divert[ing] the rights and assets of AIG and its shareholders to itself and favored third parties" through transactions involving ML III, an entity controlled by the FRBNY, and by "participating in, and causing AIG's officers and directors to participate in, the evasion of AIG's existing Common Stock shareholders' right to approve the massive issuance of the new Common Shares required to complete the government's taking of a nearly 80 percent interest in the Common Stock of AIG." SICO also alleges that the "FRBNY has asserted that in exercising its control over, and acting on behalf of, AIG it did not act in an official, governmental capacity or at the direction of the United States," but that "[t]o the extent the proof at or prior to trial shows that the FRBNY did in fact act in a governmental capacity, or at the direction of the United States, the improper conduct . . . constitutes the discriminatory takings of the property and property rights of AIG without due process or just compensation."
In rulings dated July 2, 2012, and September 17, 2012, the Court of Federal Claims largely denied the United States' motion to dismiss in the SICO Treasury Action. Discovery is proceeding. On December 3, 2012, SICO moved for class certification.
On November 19, 2012, the Southern District of New York granted the FRBNY's motion to dismiss the SICO New York Action. On December 21, 2012, SICO filed a notice of appeal in the United States Court of Appeals for the Second Circuit.
The United States has alleged, as an affirmative defense in its answer, that AIG is obligated to indemnify the FRBNY and its representatives, including the Federal Reserve Board of Governors and the United States (as the FRBNY's principal), for any recovery in the SICO Treasury Action, and seeks a contingent offset or recoupment for the value of net operating loss benefits the United States alleges that we received as a result of the government's assistance. The FRBNY has also requested indemnification under the FRBNY Credit Facility from AIG in connection with the SICO New York Action and from ML III under the Master Investment and Credit Agreement and the Amended and Restated Limited Liability Company Agreement of ML III.
In both of the actions commenced by SICO, the only claims naming AIG as a party (nominal defendant) are derivative claims on behalf of AIG. On September 21, 2012, SICO made a pre-litigation demand on our Board demanding that we pursue the derivative claims in both actions or allow SICO to pursue the claims on our behalf. On January 9, 2013, our Board unanimously refused SICO's demand in its entirety and on January 23, 2013, counsel for the Board sent a letter to counsel for SICO describing the process by which our Board considered and refused SICO's demand and stating the reasons for our Board's determination.
Additionally, a determination that AIG triggered a "bankruptcy" event of default under the swap agreement could also, depending on the Court's precise holding, affect other AIG or AIGFP agreements that contain the same or similar default provisions. Such a determination could also affect derivative agreements or other contracts between third parties, such as credit default swaps under which AIG is a reference credit, which could affect the trading price of AIG securities. During the third quarter of 2011, beneficiaries of certain previously repaid AIGFP guaranteed investment agreements brought an action against AIG Parent and AIGFP making "bankruptcy" event of default allegations similar to those made by Brookfield. The Court subsequently issued a decision dismissing that action, which is currently on appeal.
Behm matter. Frank Behm, former President of AIG Global Real Estate Asia Pacific, Inc. (AIGGREAP), has filed two actions in connection with the termination of his employment. Behm filed an action on or about October 1, 2010 in Delaware Superior Court in which he asserts claims of breach of implied covenant of good faith and fair dealing for termination in violation of public policy, deprivation of compensation, and breach of contract. Additionally, on or about March 29, 2011, Behm filed an arbitration proceeding before the American Arbitration Association alleging wrongful termination, in which he sought the payment of carried interest or "promote" distributed through the SPEs, based on the sales of certain real estate assets. Behm also contended that he was entitled to promote as a third-party beneficiary of Kevin Fitzpatrick's employment agreement, which, Behm claimed, defined broadly a class of individuals, allegedly including himself, who, with the approval of our former Chief Investment Officer, became eligible to receive promote payments. Behm claimed approximately $67 million in carried interest. Multiple AIG entities (the AIG Entities) are named as parties in each of the Behm matters. The AIG Entities have filed a counterclaim in the Delaware case, contending that Behm owes them approximately $3.6 million (before pre-judgment interest) in tax equalization payments made by the AIG Entities on Behm's behalf.
The Delaware Superior Court action is currently in discovery, and Behm has not articulated the specific amounts of money that he claims are due. As a result, we are unable to reasonably estimate the possible loss or range of losses, if any, arising from the litigation.
In addition to the escrowed funds, $800 million was deposited into, and subsequently disbursed by, a fund under the supervision of the SEC, to resolve claims asserted against AIG by investors, including the securities class action and shareholder lawsuits described below.
more broad conspiracies to allocate customers, steer business, and rig bids. These actions, including 24 complaints filed in different federal courts naming AIG or an AIG subsidiary as a defendant, were consolidated by the judicial panel on multi-district litigation and transferred to the United States District Court for the District of New Jersey (District of New Jersey) for coordinated pretrial proceedings. The consolidated actions have proceeded in that Court in two parallel actions, In re Insurance Brokerage Antitrust Litigation (the Commercial Complaint) and In re Employee Benefits Insurance Brokerage Antitrust Litigation (the Employee Benefits Complaint, and, together with the Commercial Complaint, the Multi-District Litigation).
The plaintiffs in the Commercial Complaint are a group of corporations, individuals and public entities that contracted with the broker defendants for the provision of insurance brokerage services for a variety of insurance needs. The broker defendants are alleged to have placed insurance coverage on the plaintiffs' behalf with a number of insurance companies named as defendants, including AIG subsidiaries. The Commercial Complaint also named various brokers and other insurers as defendants (three of which have since settled). The Commercial Complaint alleges that defendants engaged in a number of overlapping "broker-centered" conspiracies to allocate customers through the payment of contingent commissions to brokers and through purported "bid-rigging" practices. It also alleges that the insurer and broker defendants participated in a "global" conspiracy not to disclose to policyholders the payment of contingent commissions. Plaintiffs assert that the defendants violated the Sherman Antitrust Act, RICO, and the antitrust laws of 48 states and the District of Columbia, and are liable under common law breach of fiduciary duty and unjust enrichment theories. Plaintiffs seek treble damages plus interest and attorneys' fees as a result of the alleged RICO and Sherman Antitrust Act violations.
On April 1, 2009, Safeco Insurance Company of America (Safeco) and Ohio Casualty Insurance Company (Ohio Casualty) filed a complaint in the Northern District of Illinois, on behalf of a purported class of all NWCRP participant members, against AIG and certain of its subsidiaries with respect to the underpayment by AIG of its residual market assessments for workers' compensation insurance. The complaint was styled as an "alternative complaint," should the Northern District of Illinois grant our motion to dismiss the NCCI lawsuit for lack of subject-matter jurisdiction, which motion to dismiss was ultimately granted on August 23, 2009. The allegations in the class action complaint are substantially similar to those filed by the NWCRP.
On February 28, 2012, the Northern District of Illinois entered a final order and judgment approving a class action settlement between us and a group of intervening plaintiffs, made up of seven participating members of the NWCRP, which would require AIG to pay $450 million to satisfy all liabilities to the class members arising out of the workers' compensation premium reporting issues, a portion of which would be funded out of the remaining amount held in the Workers' Compensation Fund. Liberty Mutual filed papers in opposition to approval of the proposed settlement and in opposition to certification of a settlement class, in which it alleged our actual exposure, should the class action continue through judgment, to be in excess of $3 billion. We dispute this allegation. Liberty Mutual and its subsidiaries Safeco and Ohio Casualty subsequently appealed the Northern District of Illinois' final order and judgment to the United States Court of Appeals for the Seventh Circuit (the Seventh Circuit). On January 10, 2013, AIG and Liberty Mutual entered into a settlement under which Liberty Mutual, Safeco and Ohio Casualty agreed voluntarily to withdraw their appeals. In furtherance of such settlement, AIG, the Liberty Mutual parties and the settlement class plaintiffs submitted an agreed stipulation of dismissal that is currently under review by the Seventh Circuit.
On August 15, 2012, the trial court entered an order granting plaintiffs' motion for class certification. AIG and the other defendants have appealed that order to the Alabama Supreme Court, and the case in the trial court will be stayed until that appeal is resolved. General discovery has not commenced and AIG is unable to reasonably estimate the possible loss or range of losses, if any, arising from the litigation.
Regulatory Matters AIG's life insurance companies have received industry-wide regulatory inquiries, including a multi-state audit and market conduct examination covering compliance with unclaimed property laws and a directive from the New York Insurance Department regarding claims settlement practices and other related state regulatory inquiries. AIG recorded an increase of $55 million in policyholders benefit reserves in the third quarter of 2012 in conjunction with the resolution of the multi-state examinations relating to the handling of unclaimed property and the use of the Social Security Death Master File (SSDMF) to identify potential claims not yet presented to AIG in the normal course of business. In addition, AIG paid an $11 million regulatory assessment to the various state insurance departments that are parties to the regulatory settlement to defray costs of their examinations and monitoring. Although AIG has enhanced its claims practices to include use of the SSDMF, it is possible that the settlement remediation requirements, remaining inquiries, other regulatory activity or litigation could result in the payment of additional amounts. AIG has also received a demand letter from a purported AIG shareholder requesting that the Board of Directors investigate these matters, and bring appropriate legal proceedings against any person identified by the investigation as engaging in misconduct. AIG believes it has adequately reserved for such claims, but there can be no assurance that the ultimate cost will not vary, perhaps materially, from its estimate.
Industry-wide examinations conducted by the Minnesota Department of Insurance and the Department of Housing and Urban Development (HUD) on captive reinsurance practices by lenders and mortgage insurance companies, including UGC, have been ongoing for several years. In 2011, the Consumer Financial Protection Bureau ("CFPB") assumed responsibility for violations of the Real Estate Settlement Procedures Act from HUD, and assumed HUD's aforementioned ongoing investigation. In June 2012, the CFPB issued a Civil Investigative Demand ("CID") to UGC and other mortgage insurance companies, requesting the production of documents and answers to written questions. The CFPB agreed to toll the deadlines associated with the CID pending discussions that could resolve the investigation. Although UGC filed a petition to modify the CID on December 7, 2012, ending the tolling period, the discussions that could resolve the investigation are still ongoing. UGC has received a proposed consent order from the Minnesota Commissioner of Commerce (the MN Commissioner) which alleges that UGC violated the Real Estate Settlement Procedures Act, the Fair Credit Reporting Act and other state and federal laws in connection with its practices with captive reinsurance companies owned by lenders. UGC engaged in discussions with the MN Commissioner with respect to the terms of the proposed consent order. UGC cannot predict if or when a consent order may be entered into or, if entered into, what the terms of the final consent order will be. UGC is also currently subject to civil litigation relating to its placement of reinsurance with captives owned by lenders, and may be subject to additional litigation relating to the conduct of such business from time to time in the ordinary course.
Although we regularly review the adequacy of the established Liability for unpaid claims and claims adjustment expense, there can be no assurance that our loss reserves will not develop adversely and have a material adverse effect on our results of operations. Estimation of ultimate net losses, loss expenses and loss reserves is a complex process, particularly for long-tail casualty lines of business, which include, but are not limited to, general liability, commercial automobile liability, environmental, workers' compensation, excess casualty and crisis management
coverages, insurance and risk management programs for large corporate customers and other customized structured insurance products, as well as excess and umbrella liability, directors and officers and products liability. Generally, actual historical loss development factors are used to project future loss development. However, there can be no assurance that future loss development patterns will be the same as in the past. Moreover, any deviation in loss cost trends or in loss development factors might not be identified for an extended period of time subsequent to the recording of the initial loss reserve estimates for any accident year. There is the potential for reserves with respect to a number of years to be significantly affected by changes in loss cost trends or loss development factors that were relied upon in setting the reserves. These changes in loss cost trends or loss development factors could be attributable to changes in economic conditions in the United States and abroad, changes in the legal, regulatory, judicial and social environment, changes in medical cost trends (inflation, intensity and utilization of medical services), underlying policy pricing, terms and conditions, and claims handling practices.
Rent expense was $445 million, $482 million and $587 million for the years ended December 31, 2012, 2011 and 2010, respectively. These amounts include $16 million, $37 million and $129 million attributable to discontinued operations for the years ended December 31, 2012, 2011 and 2010, respectively.
In the normal course of business, we enter into commitments to invest in limited partnerships, private equity funds, hedge funds and mutual funds and to purchase and develop real estate in the U.S. and abroad. These commitments totaled $2.3 billion at December 31, 2012.
In connection with AIGFP's business activities, AIGFP has issued, in a limited number of transactions, standby letters of credit or similar facilities to equity investors in an amount equal to the termination value owing to the equity investor by the lessee in the event of a lessee default (the equity termination value). The total amount outstanding at December 31, 2012 was $306 million. In those transactions, AIGFP has agreed to pay such amount if the lessee fails to pay. The amount payable by AIGFP is, in certain cases, partially offset by amounts payable under other instruments typically equal to the present value of scheduled payments to be made by AIGFP. In the event that AIGFP is required to make a payment to the equity investor, the lessee is unconditionally obligated to reimburse AIGFP. To the extent that the equity investor is paid the equity termination value from the standby letter of credit and/or other sources, including payments by the lessee, AIGFP takes an assignment of the equity investor's rights under the lease of the underlying property. Because the obligations of the lessee under the lease transactions are generally economically defeased, lessee bankruptcy is the most likely circumstance in which AIGFP would be required to pay.
We are unable to develop a reasonable estimate of the maximum potential payout under certain of these arrangements. Overall, we believe that it is unlikely it will have to make any material payments related to completed sales under these arrangements, and no material liabilities related to these arrangements have been recorded in the Consolidated Balance Sheet. See Note 4 herein for additional information on sales of businesses and asset dispositions.
Pursuant to the terms of the ALICO stock purchase agreement, we have agreed to provide MetLife with certain indemnities. The most significant remaining indemnities include:
•See Note 27 herein for additional disclosures on guarantees of outstanding debt.
Payment of future dividends to our shareholders depends in part on the regulatory framework that will ultimately be applicable to us, including our status as a savings and loan holding company under Dodd-Frank and whether we are determined to be a SIFI. In addition, dividends will be payable on AIG Common Stock only when, as and if declared by our Board of Directors in its discretion, from funds legally available therefor. In considering whether to pay a dividend or purchase shares of AIG Common Stock, our Board of Directors will take into account such matters as our financial position, the performance of our businesses, our consolidated financial condition, results of operations and liquidity, available capital, the existence of investment opportunities, contractual, legal and regulatory restrictions on the payment of dividends by our subsidiaries, rating agency considerations, including the potential effect on our debt ratings, and such other factors as our Board may deem relevant. We did not pay any cash dividends in 2011 or 2012.
Through registered public offerings, the Department of the Treasury has disposed of all of its ownership of AIG Common Stock as of December 31, 2012, from ownership of approximately 92 percent (1.7 billion shares) prior to the completion of the first registered public offering initiated by the Department of the Treasury as selling shareholder in May 2011. During 2012, the Department of the Treasury, as selling shareholder, completed registered public offerings of AIG Common Stock on March 13 (the March Offering), May 10 (the May Offering), August 8 (the August Offering), September 14 (the September Offering) and December 14 (the December Offering). We participated as a purchaser in the first four 2012 offerings.
In November 2011, our Board of Directors authorized the purchase of shares of AIG Common Stock, with an aggregate purchase amount of up to $1 billion from time to time in the open market, through derivative or automatic purchase contracts or otherwise. This authorization replaced all prior AIG Common Stock purchase authorizations. We purchased a total of 3,074,031 shares of AIG Common Stock for approximately $70 million in 2011.
The junior subordinated debentures were recorded as Other long-term debt in the Consolidated Balance Sheet. The principal amount we owed on the subordinated debentures was equal to the amount owed to us under the related stock purchase contract.
(a) Includes the pre-tax adjustment to Accumulated other comprehensive income related to a $152 million reduction of deferred acquisition costs as a consequence of the recognition of additional policyholder benefit reserves disclosed below.
As a result of divestitures in 2010, $1.8 billion of Foreign currency cumulative translation adjustment and $6.1 billion of Unrealized appreciation of investments were transferred to earnings as net gain on sale.
During the first quarter of 2012, the liquidation preference of the AIA SPV Preferred Interests was paid down in full. See Note 16 herein for a discussion of indemnity payments made to MetLife pursuant to the terms of the ALICO stock purchase agreement.
For the years ended December 31, 2012 and 2011, the Noncontrolling interests balance declined by $188 million and $707 million, respectively. In 2012, this decline was primarily caused by an adjustment for the reclassification of noncontrolling interest from permanent to temporary and acquisitions of noncontrolling interests in 2012. In 2011, the decline in noncontrolling interest balance was mostly due to the acquisition of Fuji's noncontrolling interest.
Basic and diluted earnings (loss) per share are based on the weighted average number of common shares outstanding, adjusted to reflect all stock dividends and stock splits. Diluted EPS is based on those shares used in basic EPS plus shares that would have been outstanding assuming issuance of common shares for all dilutive potential common shares outstanding, adjusted to reflect all stock dividends and stock splits. Basic EPS was not affected by outstanding stock purchase contracts. Diluted EPS was not affected by outstanding stock purchase contracts because they were not dilutive.
In connection with the issuance of the Series C Preferred Stock, we applied the two-class method for calculating EPS. The two-class method is an earnings allocation method for computing EPS when a company's capital structure includes either two or more classes of common stock or common stock and participating securities. This method determines EPS based on dividends declared on common stock and participating securities (i.e., distributed earnings), as well as participation rights of participating securities in any undistributed earnings. The Series C Preferred Stock was retired as part of the Recapitalization on January 14, 2011.
We applied the two-class method due to the participation rights of the Series C Preferred Stock through January 14, 2011. However, application of the two-class method had no effect on earnings per share for 2011 because we recognized a net loss attributable to AIG common shareholders from continuing operations, which is not applicable to participating stock for EPS, for 2011. Subsequent to January 14, 2011, we have not had any outstanding participating securities that would subject us to the two-class method.
•the fair value of the consideration transferred to the Department of the Treasury, which consisted of 1,092,169,866 shares of AIG Common Stock, $20.2 billion of AIA SPV Preferred Interests and ALICO SPV Preferred Interests, and a liability for a commitment by us to pay the Department of the Treasury's costs to dispose of all of its shares, over
The following table presents statutory surplus and net income (loss) for our property casualty and life insurance and retirement services operations in accordance with statutory accounting practices:
(b) The 2011 amount was increased by $917 million for Property casualty and decreased $267 million for Life insurance and retirement services.
There are also various local restrictions limiting cash loans and advances to us by our subsidiaries. Largely as a result of these restrictions, approximately 92 percent of the aggregate equity of our consolidated insurance operations was restricted from transfer to AIG Parent at December 31, 2012. We cannot predict how regulatory investigations may affect the ability of our regulated subsidiaries to pay dividends.
* As of December 31, 2012, compensation expense for the majority of our outstanding share-based awards is attributed to liability-classified awards, the value of which are based on our share price at the reporting date. Our share price was $35.30, $23.20 and $57.62 at December 31, 2012, December 31, 2011 and December 31, 2010, respectively, and is the primary driver of the volatility in share-based compensation expense. Pre-tax share-based compensation expense related to discontinued operations for the years ended December 31, 2012, 2011 and 2010 of $15 million ($10 million after tax), ($4 million) (($3 million) after tax) and $18 million ($13 million after tax), respectively, is also included.
Our employees are granted awards under the AIG 2010 Stock Incentive Plan, as amended (2010 Plan), under which we have issued restricted stock, restricted stock units (RSUs) and stock appreciation rights (SARs). The 2010 Plan supersedes all plans for which share-based awards remain outstanding and is currently the only plan under which share-based awards can be issued.
However, of all grants made under the legacy plans, only grants under the 2007 Stock Incentive Plan (the 2007 Plan) and the Starr International Company, Inc. Deferred Compensation Profit Participation Plans (the SICO Plans) remain unvested as of December 31, 2012.
Our non-employee directors received share-based compensation in the form of deferred stock units (DSUs) under the 2010 Plan with delivery deferred until retirement from the Board. In 2012, 2011 and 2010, we granted to directors 19,434, 21,203 and 14,484 DSUs, respectively.
The aggregate intrinsic value for all unexercised options is zero, and no unrecognized compensation costs remain for stock options under these plans at December 31, 2012.
The 2007 Plan was adopted at the 2007 Annual Meeting of Shareholders. The 2010 Plan superseded the 2007 Plan, therefore, there were no grants made under the 2007 Plan subsequent to May 11, 2010. During 2010, 114,521 time-vested RSUs were granted under the 2007 Plan and vest on the second or the third anniversary of the date of grant.
The following table summarizes outstanding share-settled awards and RSUs that are fully vested on the date of grant but subject to transfer restrictions under the foregoing plans(a):
(b) Excludes legacy Deferred Compensation Profit Participation and Partners Plan for which the final installments (38,959 RSUs) vested on January 1, 2012.
The total unrecognized compensation cost (net of expected forfeitures) related to unvested SICO awards is $46 million and the weighted-average and expected period of years over which those costs are expected to be recognized are 5.44 years and 27 years, respectively. The unrecognized expense for all other awards totals less than $1 million, with a weighted average period of less than one year.
Unlike stock-settled awards, which have a fixed grant-date fair value (unless the award is subsequently modified), the fair value of unsettled or unvested liability awards is remeasured at the end of each reporting period based on the change in fair value of one share of AIG Common Stock. The liability and corresponding expense are adjusted accordingly until the award is settled.
TARP RSUs awarded require the achievement of objective performance metrics as a condition to entitlement. When vested and transferable, an award would be settled in 25 percent installments in proportion to the settlement of our TARP obligations. Prior to December 2011, TARP RSUs granted to the Top 25 (other than our CEO) vested on the third anniversary of grant, while TARP RSUs granted to the Top 26-100 vested on the second anniversary of grant and are subject to transferability restrictions for an additional year after vesting. As of December 2011, all TARP RSUs granted will vest in two 50 percent installments on the second and third anniversary of the date of grant. Our TARP obligations were fully repaid in December 2012. Accordingly, 100 percent of outstanding TARP RSUs will vest once the service requirements are satisfied.
Fully-vested RSUs totaling 271,131 were issued in March 2011 to certain employees in the Top 26-100 based on 2010 performance. Similarly, 301,645 fully vested RSUs were issued in March 2010 for performance in 2009. The RSUs for both awards will be cash-settled in March 2014 and 2013 for the 2010 and 2009 grants, respectively, based on the value of AIG Common Stock on each settlement date. Compensation expense totaling $8 million and $9 million was recorded in December 2010 and December 2009, respectively, when the awards were initially granted and $4 million was recorded for those awards that remained unsettled at December 31, 2012.
During 2012, with the exception of 139,169 fully-vested RSUs issued to certain employees, RSUs granted and issued in March 2012 for Recipients' 2011 performance will vest in two 50 percent installments on the second and third anniversary of the date of grant.
Under our Long-Term Incentive Plan (LTIP), certain employees are offered the opportunity to receive additional compensation in the form of cash and/or SARs if certain performance metrics are met. The ultimate value of LTIP awards is contingent on the achievement of performance measures aligned to the participant's business unit over a two-year period and such value could range from zero to twice the target amount. Subsequent to the performance period, the earned awards are subject to an additional time-vesting period. This results in a graded vesting schedule for the cash portion of up to two years, while the SARs portion cliff-vests two years after the performance period ends. For a majority of SARs issued under the 2011 LTIP, the strike price, which is based on our average share price over the 30-day period prior to the March grant date, was $37.40. On January 19, 2011, the previous strike price of $31.91 for SARs issued under both the 2010 LTIP and the 2009 LTIP was adjusted to $26.97 pursuant to anti-dilution provisions of the LTIP due to the issuance of warrants in connection with the Recapitalization (see Note 25 for additional discussion). No SARs were granted in connection with the 2012 LTIP.
(c) Pursuant to the terms of the LTIP, vesting was accelerated for SARs awarded to employees who became retirement eligible or were deceased.
(a) The dividend yield is estimated at zero percent given our recent dividend history. See Note 17 herein for additional information.
(d) The term to maturity is specified in the contract of each SARs grant.
We offer various defined benefit plans to eligible employees based on years of service.
We also sponsor several non-qualified unfunded defined benefit plans for certain employees, including key executives, designed to supplement pension benefits provided by the qualified plan. These include the AIG Non-Qualified Retirement Income Plan (AIG NQRIP) formerly known as AIG Excess Retirement Income Plan, which provides a benefit equal to the reduction in benefits payable to certain employees under the qualified plan as a result of federal tax limitations on compensation and benefits payable, and the Supplemental Executive Retirement Plan (Supplemental), which provides additional retirement benefits to designated executives. Under the Supplemental plan, an annual benefit accrues at a percentage of final average pay multiplied by each year of credited service, not greater than 60 percent of final average pay, reduced by any benefits from the current and any predecessor retirement plans (including the AIG NQRIP Plan), Social Security, and any benefits accrued under a Company sponsored foreign deferred compensation plan. As of December 2012, we are no longer subject to the Special Master for TARP Executive Compensation; therefore, the suspension of future benefit accruals in the non-qualified retirement plans for our Top 100 most highly compensated employees is lifted.
U.S. postretirement medical and life insurance benefits are based upon the employee attaining the age of 55 and having a minimum of ten years of service. Eligible employees who have medical coverage can enroll in retiree medical without having to elect immediate retirement pension benefits. Medical benefits are contributory, while the life insurance benefits are generally non-contributory. Retiree medical contributions vary from requiring no cost for pre-1989 retirees to requiring actual premium payments reduced by certain subsidies for post-1993 retirees. These contributions are subject to adjustment annually. Other cost sharing features of the medical plan include deductibles, coinsurance and Medicare coordination. Effective April 1, 2012, the retiree medical employer subsidy for the AIG Postretirement plan was eliminated for employees who were not grandfathered. Additionally, new employees hired after December 31, 2012 are not eligible for retiree life insurance.
(b) Includes non-qualified unfunded plans of which the aggregate projected benefit obligation was $238 million and $210 million for the U.S. and $299 million and $267 million for the non-U.S. at December 31, 2012 and 2011, respectively.
The following table presents the accumulated benefit obligations for U.S. and Non-U.S. pension benefit plans:
The estimated net loss and prior service credit that will be amortized from Accumulated other comprehensive income into net periodic benefit cost over the next fiscal year are $145 million and $37 million, respectively, for our combined defined benefit pension plans. For the defined benefit postretirement plans, the estimated amortization from Accumulated other comprehensive income for net loss and prior service credit that will be amortized into net periodic benefit cost over the next fiscal year will be less than $9 million in the aggregate.
The annual pension expense in 2013 for the AIG U.S. and non-U.S. defined benefit pension plans is expected to be approximately $292 million including less than $1 million associated with ILFC. A 100 basis point increase in the discount rate or expected long-term rate of return would decrease the 2013 expense by approximately $90 million and $43 million, respectively, with all other items remaining the same. Conversely, a 100 basis point decrease in the discount rate or expected long-term rate of return would increase the 2013 expense by approximately $96 million and $43 million, respectively, with all other items remaining the same.
Our postretirement plans provide benefits primarily in the form of defined employer contributions rather than defined employer benefits. Changes in the assumed healthcare cost trend rate are subject to caps for U.S. plans. Our non-U.S. postretirement plans are not subject to caps.
The projected benefit cash flows under the U.S. AIG Retirement plan were discounted using the spot rates derived from the Mercer Pension Discount Yield Curve at December 31, 2012 and December 31, 2011, which resulted in a single discount rate that would produce the same liability at the respective measurement dates. The discount rates were 3.94 percent at December 31, 2012 and 4.62 percent at December 31, 2011. The methodology was consistently applied for the respective years in determining the discount rates for the other U.S. plans.
There were no shares of AIG Common Stock included in the U.S. and non-U.S. pension plans assets at December 31, 2012 or 2011.
The long-term strategic asset allocation is reviewed and revised approximately every three years. The plans' assets are monitored by the investment committee of our Retirement Board and the investment managers, which includes allocating the plans' assets among approved asset classes within pre-approved ranges permitted by the strategic allocation.
The expected weighted average long-term rates of return for our non-U.S. pension plans was 2.91 and 3.14 percent for the years ended December 31, 2012 and 2011, respectively. The expected rate of return for each country is an aggregation of expected returns within each asset class for such country. For each country, the return with respect to each asset class was developed based on a building block approach that considers historical returns, current market conditions, asset volatility and the expectations for future market returns.
(a) Includes index funds that primarily track several indices including S&P 500 and S&P Small Cap 600 in addition to other actively managed accounts comprised of investments in large cap companies.
The inputs or methodologies used for valuing securities are not necessarily an indication of the risk associated with investing in these securities. Based on our investment strategy, we have no significant concentrations of risks.
The U.S. pension plan holds a group annuity contract with US Life, one of our subsidiaries, which totaled $29 million and $31 million at December 31, 2012 and 2011, respectively.
Pre-tax expenses associated with this plan were $132 million, $98 million and $102 million in 2012, 2011 and 2010 respectively, excluding approximately $1 million per year relating to ILFC.
A Schedule 13G/A filed February 14, 2013 reports aggregate ownership of 110,209,093 shares, or approximately 7.3 percent (based on the AIG Common Stock outstanding, as adjusted to reflect the warrants owned), of AIG Common Stock and warrants (85,862,294 shares plus 24,346,799 warrants) as of December 31, 2012, including securities beneficially owned by The Fairholme Fund and other funds and investment vehicles managed by Fairholme Capital Management and securities owned by Mr. Bruce Berkowitz personally. The calculation of ownership interest for purposes of the AIG Tax Asset Protection Plan and Article 13 of our Restated Certificate of Incorporation is different than beneficial ownership for Schedule 13G.
For the year ended December 31, 2012, the effective tax rate on pre-tax income from continuing operations was 16.8 percent. The effective tax rate for the year ended December 31, 2012, attributable to continuing operations differs from the statutory rate primarily due to tax benefits of $1.9 billion related to a decrease in the life-insurance-business capital loss carryforward valuation allowance and $302 million associated with tax exempt interest income. These items were partially offset by charges of $586 million related to uncertain tax positions and $172 million associated with the effect of foreign operations.
For the year ended December 31, 2011, the effective tax rate on pre-tax income from continuing operations was not meaningful, due to the significant effect of releasing approximately $18.4 billion of the deferred tax asset valuation allowance. Other factors that contributed to the difference from the statutory rate included tax benefits of $454 million associated with tax exempt interest income, $386 million associated with the effect of foreign operations, and $224 million related to our investment in subsidiaries and partnerships.
Our framework for assessing the recoverability of deferred tax assets weighs the sustainability of recent operating profitability, the predictability of future operating profitability of the character necessary to realize the deferred tax assets, and our emergence from cumulative losses in recent years. The framework requires us to consider all available evidence, including:
•the sustainability of recent operating profitability of our subsidiaries in various tax jurisdictions;
For the year ended December 31, 2012, AIG released $2.1 billion of its deferred tax asset valuation allowance associated with the life insurance business capital loss carryforwards, of which $1.9 billion was allocated to income from continuing operations. Additional life insurance business capital loss carryforwards may be realized in the future if and when other prudent and feasible tax planning strategies are identified. Changes in market conditions, including rising interest rates above AIG's projections, may result in a reduction in projected taxable gains and reestablishment of a valuation allowance.
At December 31, 2012, and December 31, 2011, our U.S. consolidated income tax group had net deferred tax assets (liabilities) after valuation allowance of $17.3 billion and $19.2 billion, respectively. At December 31, 2012, and December 31, 2011, our U.S. consolidated income tax group had valuation allowances of $5.1 billion and $7.2 billion, respectively.
On March 20, 2008, we received a Statutory Notice of Deficiency (Notice) from the IRS for years 1997 to 1999. The Notice asserted that we owe additional taxes and penalties for these years primarily due to the disallowance of foreign tax credits associated with cross-border financing transactions. The transactions that are the subject of the Notice extend beyond the period covered by the Notice, and the IRS is challenging the later periods. It is also possible that the IRS will consider other transactions to be similar to these transactions. We have paid the assessed tax plus interest and penalties for 1997 to 1999. On February 26, 2009, we filed a complaint in the United States District Court for the Southern District of New York seeking a refund of approximately $306 million in taxes, interest and penalties paid with respect to its 1997 taxable year. We allege that the IRS improperly disallowed foreign tax credits and that our taxable income should be reduced as a result of our 2005 restatement of its consolidated financial statements.
On March 29, 2011, the U.S. District Court, Southern District of New York, ruled on a motion for partial summary judgment that we filed on July 30, 2010 related to the disallowance of foreign tax credits associated with cross border financing transactions. The court denied our motion with leave to renew following the completion of discovery regarding certain transactions referred to in our motion, which we believe may be significant to the outcome of the action.
We continue to monitor legal and other developments in this area and evaluate the effect, if any, on our position, including recent decisions adverse to other taxpayers.
Interest and penalties related to unrecognized tax benefits are recognized in income tax expense. At December 31, 2012 and 2011, we had accrued liabilities of $935 million and $744 million, respectively, for the payment of interest (net of the federal benefit) and penalties. For the years ended December 31, 2012, 2011 and 2010, we accrued expense (benefits) of $189 million, $(174) million and $149 million, respectively, for the payment of interest (net of the federal benefit) and penalties.
At the Closing, we drew down approximately $20.3 billion (the Series F Closing Drawdown Amount) under the Department of the Treasury Commitment (Series F) pursuant to the Series F SPA. The Series F Closing Drawdown Amount was the full amount remaining under the Department of the Treasury Commitment (Series F), less $2 billion that we designated to be available after the closing for general corporate purposes under a commitment relating to our Series G Preferred Stock described below (the Series G Drawdown Right). Our right to draw on the Department of the Treasury Commitment (Series F) (other than the Series G Drawdown Right) was terminated.
•the shares of the Series F Preferred Stock held by the Department of the Treasury, were exchanged for (a) the SPV Preferred Interests, (b) 20,000 shares of the Series G Preferred Stock (subsequently cancelled) and (c) 167,623,733 shares of newly issued AIG Common Stock. For a discussion of the Department of the Treasury's sale of all of its ownership of AIG Common Stock, see Note 17 herein.
(c) For December 31, 2012 and December 31, 2011, includes intercompany tax payable of $6.1 billion and $9.8 billion, respectively, and intercompany derivative liabilities of $602 million and $901 million, respectively, for American International Group, Inc. (As Guarantor) and intercompany tax receivable of $120 million and $128 million, respectively, for SAFG, Inc.