We operate from approximately 160 offices in the United States and approximately 380 offices in approximately 60 foreign countries. The following offices are located in buildings in the United States owned by us:
The Selected Consolidated Financial Data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and accompanying notes included elsewhere herein.
(a) Book value per common share excluding Accumulated other comprehensive income (loss) (AOCI), Book value per common share excluding AOCI and DTA (Adjusted book value per common share), and return on equity - adjusted after-tax income excluding AOCI and DTA (Adjusted return on equity) are non-GAAP financial measures and the reconciliations to the relevant GAAP financial measures are below. For additional information see
• strategies to grow net investment income, efficiently manage capital, grow book value per common share, and reduce expenses;
• strategies for customer retention, growth, product development, market position, financial results and reserves;
• management of the impact that innovation and technology changes may have on customer preferences, the frequency or severity of losses and/or the way we distribute and underwrite our products;
It is possible that our actual results and financial condition will differ, possibly materially, from the results and financial condition indicated in these projections, goals, assumptions and statements. Factors that could cause our actual results to differ, possibly materially, from those in the specific projections, goals, assumptions and statements include:
• the timing and applicable requirements of any regulatory framework to which we are subject, including as a global systemically important insurer (G-SII);
• our ability to successfully reduce costs and expenses and make business and organizational changes without negatively impacting client relationships or our competitive position;
General operating expenses, adjusted basis is derived by making the following adjustments to general operating and other expenses: include (i) certain loss adjustment expenses, reported as policyholder benefits and losses incurred and (ii) certain investment and other expenses reported as net investment income, and exclude (i) advisory fee expenses, (ii) non-deferrable insurance commissions, (iii) direct marketing and acquisition expenses, net of deferrals and (iv) non-operating litigation reserves. We use General operating expenses, adjusted basis, because we believe it provides a more meaningful indication of our ordinary course of business operating costs, regardless of within which financial statement line item these expenses are reported externally within our segment results. The majority of these expenses are employee-related costs. For example, Other acquisition expenses and loss adjustment expenses primarily represent employee-related costs in the underwriting and claims functions, respectively. Excluded from this measure are non-operating expenses (such as restructuring costs and litigation reserves), direct marketing expenses, insurance company assessments and non-deferrable commissions.
• changes in fair value of securities used to hedge guaranteed living benefits;
• pension expense related to a one-time lump sum payment to former employees;
- Accident year loss and combined ratios, as adjusted: both the accident year loss and combined ratios, as adjusted, exclude catastrophe losses and related reinstatement premiums, prior year development, net of premium adjustments, and the impact of reserve discounting. Natural and man-made catastrophe losses are generally weather or seismic events having a net impact on AIG in excess of $10 million each and also include certain man-made events, such as terrorism and civil disorders that meet the $10 million threshold. We believe the as adjusted ratios are meaningful measures of our underwriting results on an ongoing basis as they exclude catastrophes and the impact of reserve discounting which are outside of management’s control. We also exclude prior year development to provide transparency related to current accident year results.
We use numerous assumptions in determining the best estimate of reserves for each line of business. The importance of any specific assumption can vary by both line of business and accident year. Because actual experience can differ from key assumptions used in establishing reserves, there is potential for significant variation in the development of loss reserves. This is particularly true for long-tail classes of business.
For our short-tail coverages, such as property, where the nature of claims is generally high frequency with short reporting periods, with volatility arising from occasional severe events, the process for recording non-catastrophe quarterly loss reserves is geared toward maintaining IBNR based on percentages of net earned premiums for that business, rather than projecting ultimate loss ratios based on reported losses. For example, the IBNR reserve required for the latest accident quarter for a product line such as homeowners might be approximately 20 percent of the quarter’s earned premiums. This level of reserve would generally be recorded regardless of the actual losses reported in the current quarter, thus recognizing severe events as they occur. The percent of premium factor reflects both our expectation of the ultimate loss costs associated with the line of business and the expectation of the percentage of ultimate loss costs that have not yet been reported. The expected ultimate loss costs generally reflect the average loss costs from a period of preceding accident quarters 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 line of business. The expected percentage of ultimate loss costs that have not yet been reported would be derived from historical loss emergence patterns. For more mature quarters, specific loss development methods would be used to determine the IBNR. For other product lines where the nature of claims is high frequency but low severity, methods including loss development, frequency/severity or a multiple of average monthly losses may be used to determine IBNR reserves. IBNR for claims arising from catastrophic events or events of unusual severity would be determined in close collaboration with the claims department’s knowledge of known information, using alternative techniques or expected percentages of ultimate loss cost emergence based on historical loss emergence of similar claim types.
Estimation of ultimate net losses and loss adjustment expenses (net losses) for our long-tail casualty lines of business is a complex process and depends on a number of factors, including the product line and volume of business, as well as estimates of reinsurance recoveries. Experience in the more recent accident years generally provides limited statistical credibility of reported net losses on long-tail casualty lines of business. That is because in the more recent accident years, a relatively low proportion of estimated ultimate net incurred losses are reported or paid. Therefore, IBNR reserves constitute a relatively high proportion of net losses.
· Loss development factors are used to project the reported losses for each accident year to an ultimate basis. Generally, the actual loss development factors observed from prior accident years would be used as a basis to determine the loss development factors for the subsequent accident years.
The process of determining the current loss ratio for each product line of business is based on a variety of factors. These include considerations such as: prior accident year and policy year loss ratios; rate changes; and changes in coverage, reinsurance, or mix of business. Other considerations include actual and anticipated changes in external factors such as trends in loss costs, inflation, employment rates or unemployment duration or in the legal and claims environment. The current loss ratio for each product line of business is intended to represent our best estimate after reflecting all of the relevant factors. At the close of each quarter, the assumptions and data underlying the loss ratios are reviewed to determine whether the loss ratios remain appropriate. This process includes a review of the actual loss experience in the quarter, actual rate changes achieved, actual changes in reinsurance, quantifiable changes in coverage or mix of business, and changes in other factors that may affect the loss ratio. When this review suggests that the previously determined loss ratio is no longer appropriate, the loss ratio is changed to reflect the revised estimates.
The reserve analysis for each product line of business is performed by a credentialed actuarial team in collaboration with claims, underwriting, business unit management, risk management and senior management. Our actuaries consider the ongoing applicability of prior data groupings and update numerous assumptions, including the analysis and selection of loss development and loss trend factors. They also determine and select the appropriate actuarial or other methods used to estimate reserve adequacy for each business product line, and may employ multiple methods and assumptions for each product line. These data groupings, accident year weights, method selections and assumptions necessarily change over time as business mix changes, development factors mature and become more credible and loss characteristics evolve. In the course of these detailed valuation reviews an actuarial best estimate of the loss reserve is determined. The sum of these estimates for each product line of business yields an overall actuarial best estimate for that line of business.
Our actuaries determine the appropriate actuarial methods and segmentation. This determination is based on a variety of factors including the nature of the losses associated with the product line of business, such as the frequency or severity of the claims. In addition to determining the actuarial methods, the actuaries determine the appropriate loss reserve groupings of data. This determination is a judgmental, dynamic process and refinements to the groupings are made every year. The changes to groupings may be driven by and may change to reflect observed or emerging patterns within and across product lines, or to differentiate different risk characteristics (for example, size of deductibles and extent of third party claims specialists used by our insureds). As an example of reserve segmentation, we write many unique subsets of professional liability, which cover different products, industry segments, and coverage structures. While for pricing or other purposes, it may be appropriate to evaluate the profitability of each subset individually, we believe it is appropriate to combine the subsets into larger groups for reserving purposes to produce a greater degree of credibility in the loss experience. This determination of data segmentation and related actuarial methods is assessed, reviewed and updated at least annually.
The Cape Cod method is a hybrid between the loss development and Bornhuetter Ferguson methods, where the historic loss data and loss development factor assumptions are used to determine the expected loss ratio estimate in the Bornhuetter Ferguson method.
After evaluating the historical loss development factors from prior accident years since the early 1990s, in our judgment, it is reasonably likely that the actual loss development factors could vary by an amount equivalent to a six month shift from those actually utilized in the year-end 2017 reserve review. This would impact projections both for accident years where the selections were directly based on loss development methods as well as the a priori loss ratio assumptions for accident years with selections based on Bornhuetter-Ferguson or Cape Cod methods. Similar to loss cost trends, these changes in loss development factors could be attributable to changes in inflation or in the judicial environment, or in other social or economic conditions affecting losses.
The selected loss development factors are also an important assumption, but are less critical than for U.S. Excess Casualty. Because these classes are written on a claims made basis, the loss reporting and development tail is much shorter than for U.S. Excess Casualty. However, the high severity nature of the losses does create the potential for significant deviations in loss development patterns from one year to the next. Similar to U.S. Excess Casualty, after evaluating the historical loss development factors from prior accident years since the early 1990s, in our judgment, it is reasonably likely that actual loss development factors could change by an amount equivalent to a shift by six months from those actually utilized in the year-end 2017 reserve review.
Personal Insurance is short-tailed in nature similar to Property and Special Risks but less volatile. Variance in estimates can result from unique events such as catastrophes. In addition, some subsets of this business, such as auto liability, can be impacted by changes in loss development factors and loss cost trends.
U.S. Run-off Long Tail Insurance lines is an extremely long-tail class of business, with a much greater than normal uncertainty as to the appropriate loss development factors for the tail of the loss development. Specifically for excess workers’ compensation, after evaluating the historical loss development factors for prior accident years since the 1980s as well as the development over the past several years of the ground up loss projections utilized to help select the loss development factors in the tail for this class of business, in our judgment, it is reasonably likely that the tail factor beyond 30 years could vary by 10 percent above or below that actually indicated in the 2017 loss reserve review.
The bulk of adjuster expenses are allocated and charged to individual claim files. For these expenses, we generally determine reserves based on calendar year ratios of adjuster expenses paid to losses paid for the particular product line of business. For other internal claim costs, which generally relate to specific claim department expenses that are not allocated to individual claim files such as technology costs and other broad initiatives, we look at historic and expected expenditures for these items and project these into the future.
For additional information on these features see Note 14 to the Consolidated Financial Statements.
GMWB living benefits are embedded derivatives that are required to be bifurcated from the host contract and carried at fair value. For additional information on how we reserve for variable annuity products with guaranteed benefit features see Note 14 to the Consolidated Financial Statements, and for information on fair value measurement of these embedded derivatives, including how we incorporate our own non-performance risk see Note 5 to the Consolidated Financial Statements.
• Policyholder behavior, including mortality, lapses, withdrawals and benefit utilization. Estimates of future policyholder behavior are subjective and based primarily on our historical experience
• In applying asset growth assumptions for the valuation of GMWBs, we use market-consistent assumptions calibrated to observable interest rate and equity option prices
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 the expected lives of the contracts, except in instances where significant negative gross profits are expected in one or more periods. Estimated gross profits include net investment income and spreads, net realized capital gains and losses, fees, surrender charges, expenses, and mortality gains and losses. In estimating future gross profits, lapse assumptions require judgment and can have a material impact on DAC amortization. For fixed deferred annuity contracts, the future spread between investment income and interest credited to policyholders is a significant judgment, particularly in a low interest rate environment.
In estimating future gross profits for variable annuity products as of December 31, 2017, a long-term annual asset growth assumption of 7.0 percent (before expenses that reduce the asset base from which future fees are projected) was applied to estimate the future growth in assets and related asset-based fees. In determining the asset growth rate, the effect of short-term fluctuations in the equity markets is partially mitigated through the use of a reversion to the mean methodology, whereby short-term asset growth above or below the long-term annual rate assumption impacts the growth assumption applied to the five-year period subsequent to the current balance sheet date. The reversion to the mean methodology allows us to maintain our long-term growth assumptions, while also giving consideration to the effect of actual investment performance. When actual performance significantly deviates from the annual
For a discussion of goodwill impairment see Note 12 to the Consolidated Financial Statements. In 2017, 2016 and 2015, for substantially all of the reporting units we elected to bypass the qualitative assessment of whether goodwill impairment may exist and, therefore, performed quantitative assessments that supported a conclusion that the fair value of all of the reporting units tested exceeded their book value. To determine fair value, we primarily use a discounted expected future cash flow analysis that estimates and discounts projected future distributable earnings. Such analysis is principally based on our business projections that inherently include judgments regarding business trends.
Assets and liabilities recorded at fair value in the Consolidated Balance Sheets are measured and classified in a hierarchy for disclosure purposes consisting of three “levels” based on the observability of inputs available in the marketplace used to measure the fair value.
We also assess the recoverability of deferred tax assets related to unrealized tax capital losses in the U.S. life insurance companies’ available for sale portfolio. For the year ended December 31, 2017, recent changes in market conditions, including interest rate fluctuations, impacted the unrealized tax gains and losses in the U.S. life insurance companies’ available for sale securities portfolio, resulting in a deferred tax liability related to net unrealized tax capital gains. As of December 31, 2017, based on all available evidence, we have concluded no valuation allowance is necessary in the U.S. life insurance companies’ available for sale securities portfolio.
For a discussion of our framework for assessing the recoverability of our deferred tax asset see Note 23 to the Consolidated Financial Statements.
Following the close of the DSA Re transactions, Eaglestone Reinsurance Company will continue to reinsure the AIG property casualty pool companies for their asbestos liabilities and benefit from the retroactive reinsurance agreement entered into with NICO in 2011.
Decreased primarily due to a $6.7 billion tax charge related to the enactment of the Tax Act. Excluding this tax charge, net income increased $1.5 billion due to:
• a net positive adjustment from the update of Life and Retirement actuarial assumptions in 2017 compared to a net negative adjustment in the prior year;
• higher net investment income due to increased income from alternative investments and higher appreciation on assets for which the fair value option was elected.
We continue to execute initiatives focused on organizational simplification, operational efficiency, and business rationalization.
Our business is affected by industry and economic factors such as interest rates, currency exchange rates, credit and equity market conditions, catastrophic claims events, regulation, tax policy, competition, and general economic, market and political conditions. We continued to operate under difficult market conditions in 2017, characterized by factors such as historically low interest rates, the Department of Labor’s (the DOL) final fiduciary duty rule (the DOL Fiduciary Rule), historically high levels of catastrophic events, slowing growth in China and Euro-Zone economies, and the formal commencement of the UK’s withdrawal from its membership in the European Union (the EU) (commonly referred to as Brexit). Brexit has also affected the U.S. dollar/British pound exchange rate and increased the volatility of exchange rates among the euro, British pound and the Japanese yen (the Major Currencies), which may continue for some time.
Spreads and surrender rates are important components of the future profit assumptions that drive the rate we use to amortize DAC and related reserves for investment-oriented products. If future profit assumptions change significantly, we may be required to recalculate DAC and related reserves, and reflect any resulting adjustments in current period income. In addition to investment-oriented products, certain traditional long-duration products for which we do not have the ability to adjust interest rates, such as payout annuities, are exposed to reduced earnings and potential loss recognition reserve increases in a sustained low interest rate environment.
For discussion of such adjustments recorded in our Life and Retirement and Legacy Life and Retirement Run-Off Lines see Insurance Reserves - Life and Annuity Reserves and DAC - Update of Actuarial Assumptions.
In addition, for our General Insurance segment and General Insurance run-off lines reported within the Legacy Portfolio, sustained low interest rates may unfavorably affect the net loss reserve discount for workers’ compensation, and to a lesser extent could favorably impact assumptions about future medical costs, the combined net effect of which could result in higher net loss reserves.
Uncertainty in the annuity market around the implementation of the DOL Fiduciary Rule has negatively impacted industry sales of annuity products, including those offered by Individual Retirement as reflected in declines of premiums and deposits and net flows in our variable annuity product line during the 12-month period ended December 31, 2017. Despite these effects, we believe our diverse complement of annuity product offerings position Individual Retirement and Group Retirement to effectively compete in this evolving retirement market environment.
In addition to the DOL reexamining the Fiduciary Rule, the Securities and Exchange Commission and state insurance regulators are also engaged in efforts to evaluate standards of conduct for investment advice, and to impose fiduciary duties on financial advisers who give investment advice. These regulatory initiatives may also create additional uncertainties in the annuity marketplace that could affect our distribution partners and the industry sales of annuity products. While we cannot yet predict what impact these developments will have on our businesses, we are closely following the ongoing review and assessment of the DOL Fiduciary Rule as well as these other federal and state-level developments.
On September 7, 2017, the UK Ministry of Justice announced a proposal to increase the Ogden rate from negative 0.75 percent to between zero and one percent. This proposal has to be passed by Parliament. We will continue to monitor the progress with this potential change.
The following section provides a comparative discussion of our Consolidated Results of Operations on a reported basis for the three-year period ended December 31, 2017. Factors that relate primarily to a specific business are discussed in more detail within the business segment operations section.
The following table presents a reconciliation of General operating and other expenses to General operating expense, adjusted basis, which is a Non-GAAP measure:
Pre-tax results increased in 2017 compared to 2016 primarily due to:
• an increase in General Insurance Adjusted pre-tax income due to unfavorable prior year loss reserve development of $1.0 billion in 2017 driven by higher than expected loss emergence in General Insurance primarily related to accident year 2016 compared to $5.4 billion in 2016, partially offset by higher aggregate pre-tax catastrophe losses of $4.2 billion, which included losses from Hurricanes Harvey, Irma and Maria, the earthquake in Mexico and the wildfires in California, compared to catastrophe losses of $1.3 billion in the prior year;
- movement in the non-performance or “own credit” risk adjustment (NPA), driven by tightening credit spreads and lower expected GMWB payments due to higher equity markets, and higher derivative losses from variable annuity GMWB, net of hedges, including losses from guaranteed living benefit embedded derivatives, net of hedging, primarily due to a higher net negative adjustment from updates of actuarial assumptions; and
- gains in the prior year on the sale of a portion of our investment in People’s Insurance Company (Group) of China Limited and PICC Property & Casualty Company Limited (collectively, our PICC Investment).
- a net decrease of $1.4 billion related to Life and Retirement guaranteed living benefits, net of hedges, primarily due to movement in the NPA component of the embedded derivative fair value measurement and 2016 actuarial assumption updates to surrender and mortality assumptions (see Insurance Reserves - Life and Annuity Reserves and DAC - Variable Annuity Guaranteed Benefits and Hedging Results).
• favorable adjustments to reserves and DAC in Life and Retirement, including higher net positive adjustments in 2016 to reflect the update of actuarial assumptions in Individual Retirement and Life Insurance;
• lower general operating expenses reflecting strategic actions to reduce expenses;
For the period ended December 31, 2017, we recognized a provisional estimate of income tax effects of the Tax Act of $6.7 billion, including a tax charge of $6.7 billion attributable to the reduction in the U.S. corporate income tax rate and tax benefit of $38 million related to the deemed repatriation tax.
We currently estimate that effective tax rate on future consolidated results of operations would be 21-22 percent, excluding impact of the items that cannot be forecasted. The effective tax rate is anticipated to exceed the U.S. statutory income tax rate primarily because we have operations in jurisdictions where statutory income tax rates exceed 21 percent.
- $6.7 billion associated with the enactment of the Tax Act discussed above,
The effect of foreign operations is primarily related to losses incurred in our European operations taxed at a statutory tax rate lower than 35 percent and other foreign taxes.
- $164 million associated with a portion of the U.S. Life Insurance companies capital loss carryforwards previously treated as expired that was restored and utilized,
The effect of foreign operations is primarily related to foreign exchange losses incurred by our foreign subsidiaries related to the weakening of the British pound following the Brexit vote taxed at a statutory tax rate lower than 35 percent.
For additional information see Note 23 to the Consolidated Financial Statements.
For further information on our segment changes see Note 3 to the Consolidated Financial Statements.
Property: Products include commercial, industrial and energy-related property insurance products and services that cover exposures to man-made and natural disasters, including business interruption.
Personal Lines: Products include personal auto and property in selected international markets and insurance for high net worth individuals offered through AIG Private Client Group (PCG) in the U.S. that covers auto, homeowners, umbrella, yacht, fine art and collections. In addition, we offer extended warranty insurance and services covering electronics, appliances, and HVAC.
Underwriting Excellence: Empower and increase accountability of the underwriter and continue to integrate underwriting, claims and actuarial to enable better decision making. Focus on enhancing risk selection, driving consistent underwriting best practices and building robust monitoring standards to improve underwriting results.
We believe our global presence provides Commercial Lines and Personal Insurance a distinct competitive advantage, as the demand for multinational cross-border coverage and services increase due to the internationalization of customers.
The Commercial Lines market continues to be highly competitive, with increased pressure on rates, particularly in Europe and the Asia Pacific region, due to increased market capacity. Despite this, we are continuing to grow our most profitable segments across all regions and are maintaining market leadership in key developed markets. We are actively remediating our underperforming segments, maintaining our underwriting discipline and continuing our risk selection strategy to maintain profitability.
(a) Consistent with our definition of APTI, excludes net loss reserve discount and the portion of favorable or unfavorable prior year reserve development for which we have ceded the risk under retroactive reinsurance agreements and related changes in amortization of the deferred gain.
The following tables present General Insurance accident year catastrophes and severe losses by geography(a) and number of events:
(e) The amount presented for 2017 is net of $121 million of recoveries, $65 million in North America and $56 million in International, under an aggregate reinsurance contract. Eligible incurred losses under this agreement exceeded the applicable aggregate attachment point in the fourth quarter of 2017. There were no aggregate recoveries included in the amounts presented or 2016 and 2015.
For further discussion on the NICO transaction see MD&A - Insurance Reserves.
• lower acquisition expenses driven by lower production, the impact of the reinsurance agreement with Swiss Re Group, and lower insurance taxes, licenses and fees;
• lower general operating expenses driven by lower employee-related expenses and other expense reduction initiatives; and
• higher unfavorable prior year loss reserve development (increase by $2.2 billion);
• lower general operating expenses primarily due to lower employee-related expenses and other expense reduction initiatives.
• higher ceded premiums related to the additional layer of coverage added to the North American catastrophe reinsurance cover for 2017.
• lower ceded premiums related to the reinsurance arrangement with the Swiss Re Group partially offset by lower assumed premium from the quota share reinsurance agreement with United Guaranty.
• decreased production in Casualty reflecting continued underwriting actions to strengthen our portfolio by either exiting or revising rates and terms and conditions in certain underperforming products;
• increased rate pressure, significant competition and challenging market conditions in Property and Special Risks combined with continued adherence to our underwriting discipline;
• the renewal of a large multi-year E&O policy in 2015.
• slightly elevated current accident year loss ratio, as adjusted, driven primarily by higher severe losses and an increase in loss estimates in Casualty and Financial Lines reflecting the result of 2017 detailed valuation reviews, partially offset by lower current accident year losses in Personal Insurance.
• higher prior year unfavorable loss reserve development impacted by unfavorable loss emergence in worker’s compensation and other casualty;
• higher current accident year loss ratio, as adjusted, in Casualty and programs business within Property driven by an increase in loss estimates as a result of 2016 year-end detailed reserves valuation reviews, offset slightly by lower severe losses.
This increase was partially offset by higher catastrophe losses and higher current accident year loss ratio, as adjusted, in Europe Casualty and Property.
Net premiums written decreased, excluding the impact of foreign exchange, primarily due to:
• lower production mainly in Casualty due to continued underwriting actions to strengthen our portfolio and to maintain pricing discipline; and
• lower production in personal property primarily due to the impact of a duration restriction on long-term fire insurance put in place in the fourth quarter of 2015 in Japan.
• higher current accident year loss ratio, as adjusted, in Europe Casualty driven by an increase in loss estimates as a result of 2017 year-end detailed reserve valuation reviews slightly offset by lower severe losses and improved current accident year performance in Europe and Japan Personal Insurance.
The lower expense ratio reflected a decrease in the general operating expense ratio due to lower employee-related expenses and other expense reduction initiatives.
Institutional Markets: Products primarily include stable value wrap products, structured settlement and pension risk transfer annuities, corporate- and bank-owned life insurance and guaranteed investment contracts (GICs). Institutional Markets products are primarily distributed through specialized marketing and consulting firms and structured settlement brokers.
Deliver client-centric solutions through our unique franchise by bringing together a broad portfolio of life insurance, retirement and institutional products offered through an extensive, multichannel distribution network. Life and Retirement focuses on ease of doing business, offering valuable solutions, and expanding and deepening its distribution relationships across multiple channels.
Position market leading businesses to serve growing needs by continually enhancing product solutions, service delivery and digital capabilities while using data and analytics in an innovative manner to improve customer experience.
Enhance Operational Effectiveness by simplifying processes and operating environments to increase competitiveness, improve service and product capabilities and facilitate delivery of our target customer experience. We continue to invest in technology to improve operating efficiency and ease of doing business for our distribution partners and customers. In the U.S. Life business, we are focused on leveraging our most efficient systems and increasing automation of our underwriting process. We believe that simplifying our operating models will enhance productivity and support further profitable growth.
Manage our Balance Sheet through a rigorous approach to our products and portfolio. We match our product design and high quality investments with our asset and liability exposures to maximize our ability to meet cash and liquidity needs under various operating scenarios.
Life and Retirement operates in the highly competitive insurance and financial services industry in the U.S. and select international markets, competing against various financial services companies, including mutual funds, banks and other life insurance companies. Competition is primarily based on product pricing and design, distribution, financial strength, customer service and ease of doing business.
• a sustained low interest rate environment, which makes it difficult to profitably price new products and puts margin pressure on existing business due to lower reinvestment yields;
• increased competition in our primary markets, including aggressive pricing of annuities by private equity-backed annuity writers, increased competition and consolidation of employer groups in the group retirement planning market, and peers with lower profitability targets in the pension funding space;
• increasingly complex new and proposed regulatory requirements, which have created uncertainty that is affecting industry growth; and
As life insurance ownership remains at historical lows in the United States, efforts to expand the reach and increase the affordability of life insurance are critical. The industry is investing in consumer-centric efforts to reduce traditional barriers to securing life protection by simplifying the sales and service experience. Digitally enabled processes and tools provide a fast, friendly and simple path to life insurance protection.
Life and Retirement reviews and updates estimated gross profit assumptions used to amortize DAC and related items for investment-oriented products, as well as other actuarial assumptions, at least annually. As a result, the adjusted pre-tax income of Life and Retirement included adjustments to policy fees, policyholder benefits, interest credited and DAC amortization to reflect such assumption updates, which may be significant.
The market environment reflected continued uncertainty about the DOL Fiduciary Rule and interest rates, which remained low relative to historical levels. As a result, deposits were lower in 2017 compared to 2016 and 2015. In 2017, net investment income included higher gains on securities for which the fair value option was elected and higher returns from alternative investments, partially offset by a reduction in the overall size of the hedge fund portfolio. In 2016 and 2015, net investment income included the impact of volatility from alternative investments, commercial mortgage loan prepayments and fair value option assets. Adjusted pre-tax income also included adjustments in each year to update actuarial assumptions, which were net positive adjustments for all years presented. The sale of AIG Advisor Group in May 2016 resulted in decreases in advisory fee income, advisory fee expenses and general operating expenses in 2017 compared to 2016 and 2015, but did not result in a significant decrease in adjusted pre-tax income.
• excluding the impact of actuarial assumption updates, higher DAC amortization due to system conversions and model refinements, partially offset by a decrease driven by improved equity market performance;
• higher commission expense primarily due to growth in account values driven by improved equity market performance and the allocation of reinsurance risk charges, as all U.S. Life and Retirement segments benefited from the reduction in the required statutory capital resulting from a reinsurance agreement entered into in 2016 involving certain whole life, term life and universal life businesses (Life Insurance Reinsurance Transactions); and
• lower general operating expenses due to decreases in employee-related expenses
• Fixed Annuities premiums and deposits decreased, primarily due to disciplined pricing in the continued low interest rate environment and strong sales in 2016 driven by higher equity market volatility, which made fixed annuities more attractive to customers seeking less volatile returns. Although premiums and deposits were lower compared to 2016, annuity sales in the second half of 2017 improved compared to the same period in 2016. Net flows declined and continued to be negative reflecting lower premiums and deposits, partially offset by lower surrenders.
• Variable and Index Annuities premiums and deposits and net flows declined, reflecting a continued decrease in variable annuity industry sales due in part to uncertainty around the implementation of the DOL Fiduciary Rule, partially offset by slightly higher index annuity sales. Lower premiums and deposits combined with higher surrenders resulted in a decrease in net flows.
• Variable and Index Annuities net flows were significantly lower due to a decrease in premiums and deposits, primarily due to lower sales of variable annuities, which reflected a strategic decision to scale back living benefits during the period of very low interest rates, as well as an industry-wide slowdown and uncertainty around the effect of the DOL Fiduciary Rule.
• Retail Mutual Funds net flows increased due to improvement in the level of deposits, which was partially offset by higher withdrawals, both driven by activity within the Focused Dividend Strategy Portfolio fund.
• a net positive adjustment from the review and update of actuarial assumptions which was $13 million in 2017 compared to a $47 million net negative adjustment in 2016;
• higher commission expense primarily due to the allocation of reinsurance risk charges from Life Insurance Reinsurance Transactions.
• lower net investment income on alternative investments and lower base spreads primarily due to lower investment returns, partially offset by higher commercial mortgage loan prepayments and gains on securities for which the fair value option was elected; and
For Group Retirement, premiums primarily represent amounts received on life-contingent payout annuities. Premiums in 2017 were comparable to 2016. Premiums increased in 2016 compared to 2015, as customers continued to invest in immediate annuities due to equity market volatility.
(a) Excludes mutual fund assets under administration of $20.2 billion and $16.3 billion at December 31, 2017 and 2016, respectively.
Net flows declined and continued to be negative primarily due to surrenders, including group plan surrenders of approximately $460 million. In addition, premiums and deposits decreased slightly primarily due to lower index annuity sales, partially offset by significantly higher deposits from group plan acquisitions.
Adjusted pre-tax income increased in 2017 compared to a loss in 2016 primarily due to:
• a lower negative adjustment from the review and update of actuarial assumptions, which was $92 million in 2016 compared to $118 million in 2015;
Premiums for Life Insurance represent amounts received on traditional life insurance policies, primarily term life, and group benefit policies. Premiums, excluding the effect of foreign exchange, increased nine percent in both 2017 compared to 2016 and 2016 compared to 2015, primarily due to assumed premiums related to business distributed by Laya Healthcare and growth in international life and health. Premiums in 2017 also reflected growth in term life business, partially offset by lower group benefits premiums.
Institutional Markets continued to grow its assets under management, which drove the continuous increase in net investment income over the recent years.
Adjusted pre-tax income was comparable to 2015. Decreases in premiums and policyholder benefits were primarily due to pension risk transfer business written in 2015. Growth in reserves and assets under management drove the increase in net investment income with similar impact to policyholder benefits.
Premiums for Institutional Markets represent amounts received on traditional life insurance policies and pension risk transfer annuities or structured settlements. Premiums increased in 2017 compared to 2016 and declined in 2016 compared to 2015 primarily driven by the pension risk transfer business written in 2017 and 2015. Partially offsetting the increase in 2017 was a decrease in structured settlement sales.
Premiums and deposits for Institutional Markets is a non-GAAP financial measure that includes direct premiums as well as deposits received on universal life insurance and investment-type annuity contracts, including GICs.
Adjusted pre-tax loss increased primarily due to the sale of United Guaranty during the fourth quarter of 2016.
Legacy General Insurance Run-Off Lines - consists of asbestos and environmental exposures and other exposures within certain Property and Casualty profit centers no longer actively marketed, including excess workers’ compensation, environmental impairment liability, public entity liability, accident & health, physicians and surgeons professional liability, and various other workers’ compensation and general liability exposures.
Legacy Life and Retirement Run-Off Lines - include whole life, long-term care and exited accident & health product lines. Also includes certain structured settlement, pension risk transfer annuities and single premium immediate annuities written prior to April 2012.
For Legacy Insurance Lines, securing the interests of our policyholders and insureds is paramount. We have considered and continue to evaluate the following strategies for these lines:
For Legacy Investments, our business strategy is to maximize liquidity to AIG Parent and minimize book value impairments while sourcing for our insurance companies attractive assets for their portfolios.
• increased Legacy Life and Retirement adjusted pre-tax income due to the absence of any significant loss recognition on certain payout annuities from the update of actuarial assumptions in 2017 compared to 2016. Loss recognition from the update to actuarial assumptions in 2017 was $14 million mainly attributable to the Long-Term Care portfolio;
• increased Legacy General Insurance adjusted pre-tax income due to the absence of any significant prior year development in 2017 compared to 2016.
• higher Legacy Investment adjusted pre-tax income driven mainly by asset sales, partially offset by fair value losses on certain investments.
• A decrease in interest rates and narrowing credit spreads resulted in a net unrealized gain in our investment portfolio. Net unrealized gains in our available for sale portfolio increased to approximately $13.9 billion as of December 31, 2017 from approximately $9.7 billion as of December 31, 2016.
• During the first quarter of 2017, we funded the adverse development reinsurance agreement entered into with NICO. The approximate $10.2 billion funding of this agreement was the primary reason for the decrease in the invested asset portfolio in 2017.
• Other-than-temporary impairments decreased due to lower impairments in our structured securities and corporate bond portfolios.
• Fixed maturity securities held by the U.S. insurance companies included in General Insurance consist of a mix of instruments that meet our current risk-return, tax, liquidity, credit quality and diversification objectives.
For General Insurance - North America and International and Legacy General Insurance Run-Off Lines, we estimate investable funds based primarily on loss reserves and unearned premiums. The allocation of net investment income of the General Insurance companies to segments is calculated based on these estimated investable funds, consistent with the approximate duration of the liabilities and the required economic capital allocation for each segment.
Fixed maturity securities of the General Insurance companies’ domestic operations, with an average duration of 3.9 years, are currently comprised of corporate bonds, structured securities, taxable municipal bonds and government and agency bonds as well as tax-exempt securities, which provide attractive risk-adjusted after-tax returns. The majority of these high quality investments are rated A or higher based on composite ratings.
The investment strategy of the Life and Retirement companies is to maximize net investment income and portfolio value, subject to liquidity requirements, capital constraints, diversification requirements, asset-liability management and available investment opportunities.
* Excludes $25.4 billion of fixed maturity securities for which no NAIC Designation is available because they are held in legal entities within U.S. Insurance Companies that do not require a statutory filing.
At December 31, 2017, approximately 90 percent of our fixed maturity securities were held by our domestic entities. Approximately 18 percent of these securities were rated AAA by one or more of the principal rating agencies, and approximately 16 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.
With respect to our fixed maturity securities, the credit ratings in the table below and in subsequent tables reflect: (a) a composite of the ratings of the three major rating agencies, or when agency ratings are not available, the rating assigned by the NAIC SVO (over 99 percent of total fixed maturity securities), or (b) our equivalent internal ratings when these investments have not been rated by any of the major rating agencies or the NAIC. The “Non-rated” category in those tables consists of fixed maturity securities that have not been rated by any of the major rating agencies, the NAIC or us.
Our investments in the energy category, as a percentage of total investments in available-for-sale fixed maturities, was 5.5 percent and 5.6 percent at December 31, 2017 and December 31, 2016, respectively. While the energy investments are primarily investment grade and are actively managed, the category continues to experience volatility that could adversely affect credit quality and fair value.
(a) Includes approximately $12.3 billion and $12.9 billion at December 31, 2017 and December 31, 2016, respectively, of certain RMBS that had experienced deterioration in credit quality since their origination. For additional discussion on Purchased Credit Impaired (PCI) Securities see Note 6 to the Consolidated Financial Statements.
The fair value of CMBS holdings remained stable throughout 2017. The majority of our investments in CMBS are in tranches that contain substantial protection features through collateral subordination. The majority of CMBS holdings are traditional conduit transactions, broadly diversified across property types and geographical areas.
The following table presents our CDO available for sale securities by collateral type:
At December 31, 2017, we had direct commercial mortgage loan exposure of $28.6 billion. All commercial mortgage loans were current or performing according to their restructured terms.
Impairments on life settlements in 2016 were partially attributable to an increase in policy premiums required to keep policies in force which resulted in lower future expected net cash flows that were insufficient to recover our net investment on certain policies.
Impairments on life settlements in 2015 were partially attributable to an increase in policy premiums required to keep policies in force which resulted in lower future expected net cash flows that were insufficient to recover our net investment on certain policies as well as our adoption of the Society of Actuaries 2015 Valuation Basic Table (VBT) as the market mortality assumption used to measure the fair value of impaired policies.
In addition, impairments are recorded on real estate and investments in life settlements.
(b) Represents the percentage by which fair value is less than cost at December 31, 2017.
The following table presents the components of Net realized capital losses:
(b) In 2016, primarily includes $107 million of realized gains due to a purchase price adjustment on the sale of Class B shares of Prudential Financial, Inc. and losses of $253 million from the sale of a portion of our Life Settlements portfolio. In 2015, primarily includes $357 million of realized gains due to the sale of common shares of SpringLeaf Holdings (now known as OneMain Holdings, Inc.), $428 million of realized gains due to the sale of Class B shares of Prudential Financial, Inc. and $463 million of realized losses due to the sale of ordinary shares of AerCap.
Net realized capital losses decreased in 2017 compared to 2016 due primarily to foreign exchange gains versus losses in the prior year and lower other-than-temporary impairments. Net realized capital losses in 2017 consisted primarily of variable annuity embedded derivatives, net of related hedges, and impairments, which were partially offset by gains on the sales of securities and foreign exchange gains.
During 2016, we recognized adverse prior year loss reserve development of $5.8 billion. This unfavorable development was primarily a result of the following:
• Updated loss development selections in U.S. Excess Casualty, U.S. Financial Lines and U.S. Run-off Casualty Insurance lines, most notably tail factor selections and incorporation of updated industry experience for asbestos liabilities.
• Revised estimates of expected future recoveries from risk-sharing policies in the U.S. Workers’ Compensation business.
• Updated estimates for extra-contractual obligation claims and unallocated loss adjustment expenses
Effective January 1, 2016, we entered into a two-year reinsurance arrangement with the Swiss Reinsurance Company Ltd, under which we ceded a proportional share of our new and renewal U.S. Primary Casualty portfolio in order to reduce the concentration of casualty business in our portfolio. This agreement was not renewed for new and renewal business for 2018 but remains in effect for risks attaching during the two-year term of the agreement.
(a) Prior year reserve development ceded to NICO under the retroactive reinsurance agreement is deferred under U.S. GAAP and is recognized in APTI.
Various assumptions were updated, including the following effective September 30, 2017:
• we lowered our ultimate projected yields on invested assets by approximately five to 10 basis points. Projected yields are graded from a weighted average net GAAP book yield of existing assets supporting the business based on the value of the asset to a weighted average yield based on the duration of the assets excluding assets that mature during the grading period. The grading period is three years for annuity products and five years for life insurance products.
In 2017, adjusted pre-tax income included a net positive adjustment of $270 million, primarily driven by lower lapse assumptions in Fixed Annuities, improved mortality assumptions in Life Insurance, and an increase in the reversion to the mean rates in Variable Annuities. The positive adjustments were partially offset by lower spread assumptions in Fixed Annuities and a loss recognition expense on long-term care business in the Legacy Life and Retirement Run-Off Lines.
In 2016, adjusted pre-tax income included a net negative adjustment of $384 million, primarily driven by $622 million of loss recognition reserves for pre-2010 payout annuities in the Legacy Portfolio, and an increase in Life Insurance reserves for universal life with secondary guarantees. These negative adjustments were partially offset by positive adjustments, primarily due to lower lapse assumptions in Fixed Annuities.
In Fixed Annuities, the update of estimated gross profit assumptions resulted in a net positive adjustment of $130 million in 2017, which reflected lower lapse assumptions, partially offset by lower spread assumptions. In 2016, a net positive adjustment of $330 million reflected lower lapse assumptions, primarily due to lower long-term interest rates, as well as updates to spread assumptions. In 2015, a net positive adjustment of $92 million reflected refinements to investment spread assumptions, lower terminations and decreases to expense assumptions.
In 2016, the update of estimated gross profit assumptions resulted in a net positive adjustment of $39 million in Variable and Index Annuities primarily due to favorable updates to assumptions for volatility, lapses, mortality and policy expenses, partially offset by a decrease in the separate account long-term asset growth rate assumption from 8.5 percent to 7.5 percent (before expenses that reduce the asset base from which future fees are projected). The net positive adjustment included a net negative adjustment of approximately $24 million in connection with the conversion to a new modeling platform for variable annuities, primarily due to refinements to assumptions for guaranteed minimum interest rates and investment fees, partially offset by the impact of other refinements identified during the conversion.
In Life Insurance, the update of actuarial assumptions resulted in a net positive adjustment of $29 million in 2017, primarily due to improved mortality assumptions, partially offset by lower spread assumptions. In 2016, a net negative adjustment of $92 million was primarily due to refinement to reserves for universal life insurance with secondary guarantees due to lower assumed lapse rates. The update to Life Insurance assumptions in 2016 also included lower spread assumptions. In 2015, the net negative adjustment of $118 million was primarily due to lower assumed lapse rates for certain later-duration universal life with secondary guarantees. The net negative adjustment also reflected lower investment spread assumptions, partially offset by more favorable than expected mortality.
In 2017, the update of actuarial assumptions resulted in a net negative adjustment of $14 million, primarily due to $13 million of loss recognition expense on long-term care business in the Legacy Life and Retirement Run-Off Lines resulting from model enhancements. In 2016, Legacy Life and Retirement Run-Off Lines recorded $622 million of loss recognition expense on payout annuities. The loss recognition reflected the establishment of additional reserves primarily as a result of mortality experience studies, which indicated increased longevity, particularly on disabled lives on a block of structured settlements underwritten prior to 2010. In 2015, Legacy Life and Retirement Run-Off Lines recorded loss recognition expense of $28 million to increase reserves for certain long-term care business. The loss recognition was primarily a result of lower future premium increase assumptions.
• The economic hedge target excludes the non-performance or “own credit” risk adjustment used in the U.S. GAAP valuation, which reflects a market participant’s view of our claims-paying ability by incorporating an additional spread (the NPA spread) to the swap curve used to discount projected benefit cash flows. Because the discount rate includes the NPA spread and other explicit risk margins, the U.S. GAAP valuation is generally less sensitive to movements in interest rates and other market factors, and to changes from actuarial assumption updates, than the economic hedge target. For more information on our valuation methodology for embedded derivatives within policyholder contract deposits see Note 5 to the Consolidated Financial Statements.
The market value of the hedge portfolio compared to the economic hedge target at any point in time may be different and is not expected to be fully offsetting. In addition to the derivatives held in conjunction with the variable annuity hedging program, the Life and Retirement companies have cash and invested assets available to cover future claims payable under these guarantees. The primary sources of difference between the change in the fair value of the hedging portfolio and the economic hedge target include:
The impact on our pre-tax income (loss) of the variable annuity guaranteed living benefits and related hedging results includes changes in the fair value of the GMWB embedded derivatives, and changes in the fair value of related derivative hedging instruments, both of which are recorded in Other realized capital gains (losses). Realized capital gains (losses), as well as net investment income from changes in the fair value of fixed maturity securities used in the hedging program, are excluded from adjusted pre-tax income of Individual Retirement and Group Retirement.
Change in fair value of embedded derivatives, excluding update of actuarial
The net impact on pre-tax income from the GMWB and related hedges in 2017 (excluding related DAC amortization) was primarily driven by losses from actuarial assumption updates to lapse and volatility assumptions, tightening credit spreads on the NPA spread and the impact on the NPA volume of lower expected GMWB payments, driven by higher equity markets. In 2016, the net impact on pre-tax income was primarily driven by the impact of rising interest rates and equity markets late in the fourth quarter of 2016, which resulted in fair value losses in the hedging portfolio, which were not offset by decreases in the embedded derivative liabilities as the risk margins and other assumptions used in the U.S. GAAP valuation caused the embedded derivatives to be less sensitive to market changes than the related hedge portfolio. In addition, 2016 included losses from actuarial assumption updates due to lapse and mortality assumptions. In 2015, the net impact was primarily driven by increasing NPA spread and volume, which had a positive impact on pre-tax income, partially offset by an increase in embedded derivative liabilities driven by a decline in interest rates and unfavorable equity market performance.
The change in the fair value of embedded derivatives, excluding update of actuarial assumptions and NPA, in 2017 was largely offset by the related hedging portfolio. However, in 2016, the change in fair value of embedded derivatives, excluding update of actuarial assumptions and NPA, reflected losses on the hedging portfolio driven by improvements in both interest rates and equity markets late in the fourth quarter of 2016, which were not offset by decreases in embedded derivative liabilities. In 2015, the change in the fair value of embedded derivatives, excluding update of actuarial assumptions and NPA, included losses from equity volatility, primarily in the third quarter of 2015, a decline in interest rates and unfavorable equity market performance.
• The change in the fair value of equity derivative contracts, which included futures and options, resulted in losses in 2017, 2016 and 2015, which varied based on the relative growth in equity market returns in the respective years.
The following table summarizes the major components of the changes in DAC, including VOBA, within the life and retirement companies, excluding DAC of Legacy Portfolio:
The net adjustments to DAC amortization from the update of actuarial assumptions for estimated gross profits, including those reported within change in DAC related to net realized capital gains (losses), represented two percent, four percent and one percent of the DAC balance excluding the amount related to unrealized depreciation (appreciation) of investments as of December 31, 2017, 2016 and 2015, respectively.
In 2017, we updated the long-term annual growth assumption applied to subsequent periods used in our reversion to the mean methodology for estimating future estimated gross profits for variable annuity products, from 7.5 percent to 7.0 percent (before expenses that reduce the asset base from which future fees are projected). The five-year reversion to the mean period has met the criteria for adjustment in 2017. As a result, the average gross long-term return measurement start date was reset to December 31, 2011 for Individual Retirement and June 30, 2013 for Group Retirement; the reversion to the mean rates (gross of fees) were increased to 3.74 percent in Individual Retirement and 3.78 percent for Group Retirement. Sustained favorable equity market performance in excess of long-term assumptions could result in additional unlocking in the Individual Retirement or Group Retirement variable annuity product lines in the future, with a positive effect on pre-tax income in the period of the unlocking.
See Enterprise Risk Management - Risk Appetite, Limits, Identification, and Measurement and Enterprise Risk Management - Liquidity Risk Management below for additional information.
AIG Parent also received a net amount of $2.2 billion in tax sharing payments in the form of cash and fixed maturity securities from our insurance businesses in 2017, reflecting $1.2 billion that was reimbursed by AIG Parent to our insurance businesses during the fourth quarter of 2017 primarily as a result of adjustments made to prior-year tax sharing payments. The tax sharing payments may continue to be subject to adjustment in future periods.
The dividends, loan repayments and tax sharing payments from our Life and Retirement companies resulted from and were funded, in part, by excess statutory capital released by Life Insurance Reinsurance Transactions.
For information regarding the Life Insurance Reinsurance Transactions, see Business Segment Operations - Life and Retirement.
In November 2017, we issued $400 million aggregate principal amount of Zero Coupon Callable Notes due 2047.
During 2017, we generated approximately $3.0 billion in return of capital from Legacy Investments, including through the sale of our remaining life settlements contracts.
In June 2017, AIG Parent and National Union received gross proceeds of approximately $391 million and $261 million, respectively, from the sale of approximately four million and three million shares, respectively, of common stock of Arch Capital Group Ltd. by means of an underwritten public offering.
On July 17, 2017, we redeemed $290 million aggregate principal amount of our outstanding 4.90% Callable Notes Due July 17, 2045.
We paid a cash dividend of $0.32 per share on AIG Common Stock during each quarter of 2017.
We repurchased approximately 100 million shares of AIG Common Stock during 2017, for an aggregate purchase price of approximately $6.3 billion.
Interest payments totaled $1.2 billion in 2017 compared to $1.3 billion in 2016 and $1.4 billion in 2015. Excluding interest payments, AIG had operating cash outflows of $7.3 billion in 2017 compared to operating cash inflow of $3.7 billion and $4.2 billion in 2016 and 2015 respectively. The operating cash outflow in 2017 was primarily due to payment for the adverse development reinsurance agreement entered into with NICO.
• approximately $6.3 billion to repurchase approximately 100 million shares of AIG Common Stock; and
• approximately $342 million in net outflows from the issuance and repayment of long-term debt.
• approximately $11.5 billion to repurchase approximately 201 million shares of AIG Common Stock;
• approximately $1.0 billion in the aggregate to pay a dividend of $0.125 per share on AIG Common Stock in each of the first and second quarters of 2015 and $0.28 per share on AIG Common Stock in each of the third and fourth quarters of 2015;
• approximately $2.9 billion in net outflows from the issuance and repayment of long-term debt.
As of December 31, 2017, AIG Parent had approximately $11.8 billion in liquidity sources. AIG Parent’s liquidity sources are primarily held in the form of cash, short-term investments and publicly traded, investment grade rated fixed maturity securities. Fixed maturity securities primarily include U.S. government and government sponsored entity securities, U.S. agency mortgage-backed securities, corporate and municipal bonds and certain other highly rated securities. AIG Parent actively manages its assets and liabilities in terms of products, counterparties and duration. Based upon an assessment of funding needs, the liquidity sources can be readily monetized through sales or repurchase agreements or contributed as admitted assets to regulated insurance companies. AIG Parent liquidity is monitored through the use of various internal liquidity risk measures. AIG Parent’s primary sources of liquidity are dividends, distributions, loans and other payments from subsidiaries and credit facilities. AIG Parent’s primary uses of liquidity are for debt service, capital and liability management, and operating expenses.
(a) Cash and short-term investments include reverse repurchase agreements totaling $1.7 billion and $1.0 billion as of December 31, 2017 and 2016, respectively.
Certain of our U.S. Life and Retirement companies have programs, which began in 2012, that lend securities from their investment portfolio to supplement liquidity or for other uses as deemed appropriate by management. Under these programs, these U.S. Life and Retirement 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 and Retirement company is able to lend under its program at any time is limited to five percent of its general account statutory-basis admitted assets. Our U.S. Life and Retirement companies had $2.9 billion and $2.4 billion of securities subject to these agreements at December 31, 2017 and December 31, 2016, respectively, and $3.0 billion and $2.5 billion of liabilities to borrowers for collateral received at December 31, 2017 and December 31, 2016, respectively.
We believe that our Life and Retirement companies have adequate financial resources to meet the payments actually required under these obligations. These subsidiaries have substantial liquidity in the form of cash and short-term investments. In addition, our Life and Retirement companies maintain significant levels of investment grade rated fixed maturity securities, including substantial
holdings in government and corporate bonds, and could seek to monetize those holdings in the event operating cash flows are insufficient. We expect liquidity needs related to GIC liabilities to be funded through cash flows generated from maturities and sales of invested assets.
(a) Includes construction guarantees connected to affordable housing investments by our Life and Retirement companies. Excludes potential amounts for indemnification obligations included in asset sales agreements. For further information on indemnification obligations see Note 16 to the Consolidated Financial Statements.
See Note 15 to the Consolidated Financial Statements for additional details on debt outstanding.
For a discussion of the effects of downgrades in our credit ratings see Note 11 to the Consolidated Financial Statements herein and Part I, Item 1A. Risk Factors - Liquidity, Capital and Credit.
For a discussion of the effects of downgrades in our financial strength ratings see Note 11 to the Consolidated Financial Statements herein and Part I, Item 1A. Risk Factors - Liquidity, Capital and Credit.
On February 14, 2017, our Board of Directors declared a cash dividend on AIG Common Stock of $0.32 per share, payable on March 29, 2017 to shareholders of record on March 15, 2017. On May 3, 2017, our Board of Directors declared a cash dividend on AIG Common Stock of $0.32 per share, payable on June 28, 2017 to shareholders of record on June 14, 2017. On August 2, 2017, our Board of Directors declared a cash dividend on AIG Common Stock of $0.32 per share, payable on September 29, 2017 to shareholders of record on September 15, 2017. On November 2, 2017, our Board of Directors declared a cash dividend on AIG Common Stock of $0.32 per share, payable on December 22, 2017 to shareholders of record on December 8, 2017.
On February 8, 2018, our Board of Directors declared a cash dividend on AIG Common Stock of $0.32 per share, payable on March 29, 2018 to shareholders of record on March 15, 2018. The payment of any future dividends will be at the discretion of our Board of Directors and will depend on various factors, as discussed further in Note 17 to the Consolidated Financial Statements.
During 2017, we repurchased approximately 100 million shares of AIG Common Stock for an aggregate purchase price of approximately $6.3 billion pursuant to this authorization.
We have an integrated process for managing risks throughout our organization in accordance with our firm-wide risk appetite. Our Board of Directors has oversight responsibility for the management of risk. Our Enterprise Risk Management (ERM) Department supervises and integrates the risk management functions in each of our business units, providing senior management with a consolidated view of AIG’s major risk positions. Within each business unit, senior leaders and executives approve risk-taking policies and targeted risk tolerance within the framework provided by ERM. ERM supports our businesses and management in the embedding of risk management in our key day-to-day business processes and in identifying, assessing, quantifying, managing, monitoring, reporting, and mitigating the risks taken by us and our businesses. Nevertheless, our risk management efforts may not always be successful and material adverse effects on our business, results of operations, cash flows, liquidity or financial condition may occur.
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 our Chief Executive Officer (CEO).
The scope of the TORCC includes, but is not limited to, Operational Risk Management, Technology Risk Management, Model Risk Management, Information Security, Compliance, Sarbanes Oxley, Disaster Recovery, Project Risk Management and Vendor Risk Management.
In addition, the TORCC may form, and delegate authority to, sub-committees or working groups which oversee Technology and Operational risk-related matters on its behalf with periodic reporting to the TORCC.
• BU and legal entity level limits are set to address key risks identified by ERM for the business unit and legal entities, protect capital and liquidity at legal entities and/or meet legal entity specific requirements of regulators and rating agencies. These limits are defined by the business unit and legal entity risk officers.
We employ various approaches to measure, monitor, and manage risk exposures, including the utilization of a variety of metrics and early warning indicators. We use a proprietary internal capital and stress testing framework to measure our quantifiable risks for both insurance and non-insurance operations.
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 capital needs under stress, risks inherent in our non-insurance company subsidiaries, and risks to AIG consolidated capital. 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.
Our credit risks are managed by teams of credit professionals, subject to ERM oversight and various control processes. 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:
Many of our market risk exposures related to interest rates and equity returns are associated with our Life and Retirement companies and relate to both asset and liability exposures. In addition, these exposures are long-term in nature. Examples of liability-related exposures include interest rate sensitive surrenders in our fixed deferred annuity product portfolio. Also, we have equity market risk sensitive surrenders in our variable annuity product portfolio. These interactive asset-liability types of risk exposures are regularly monitored in accordance with the risk governance framework noted above.
Our investment portfolios are exposed to the risk of changing values in a variety of residential and commercial real estate investments. Changes in residential/commercial real estate prices can affect the valuation of residential/commercial mortgages, residential/commercial mortgage-backed securities and other structured securities with underlying assets that include residential/commercial mortgages, trusts that include residential/commercial real estate and/or mortgages, residential mortgage insurance and reinsurance contracts and commercial real estate investments.
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 make some of our product offerings less attractive to investors. Conversely, higher interest rates are typically beneficial for the opposite reasons. However, when rates rise quickly, there can be a temporary asymmetric 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 universal life, fixed rate annuities, variable annuities and derivative contracts.
In addition, we continue to use enhanced economic, GAAP accounting and statutory capital-based risk measures at the market risk level, business-unit level and firm-wide levels. This process aims to ensure that we have a comprehensive view of the impact of our market risk exposures.
• a one basis point increase in credit spreads of fixed maturity securities, and
• the stock market crash of October 1987 or the widening of yields or spreads of RMBS or CMBS during 2008.
(a) At December 31, 2017, the analysis covered $276.8 billion of $289.6 billion interest-rate sensitive assets. Excluded were $8.2 billion of loans. In addition, $4.6 billion of assets across various asset categories were excluded due to modeling limitations. At December 31, 2016, the analysis covered $276.1 billion of $291.7 billion interest-rate sensitive assets. Excluded were $8.1 billion of loans and $2.5 billion of investments in life settlements. In addition, $5.0 billion of assets across various asset categories were excluded due to modeling limitations.
(c) The balance sheet exposures for equity contracts and variable annuity and other embedded derivatives are also reflected under “Interest rate sensitive liabilities” above, and are not additive.
Our foreign currency-denominated net asset position at December 31, 2017, decreased by $3.3 billion compared to December 31, 2016. The decrease was primarily due to a $1.7 billion decrease in our Japanese yen position primarily due to the sale of Fuji Life and the unwinding of certain yen hedges; a $0.7 billion decrease in our euro position primarily due to the issuance of €1.0 billion euro denominated debt; and a $248 million decrease in our British pound position primarily due to an increase in reserves.
AIG Parent liquidity risk tolerance levels are designed to allow us to meet our financial obligations for a minimum of six months under a liquidity stress scenario. We maintain liquidity limits and minimum coverage ratios designed to ensure that funding needs are met under varying market conditions. If we project that we will breach these tolerances, we will assess and determine appropriate liquidity management actions. However, the market conditions in effect at that time may not permit us to achieve an increase in liquidity sources or a reduction in liquidity requirements.
Liquidity risk is overseen at the corporate level within ERM. The CRO has responsibility for the oversight of the Liquidity Risk Management Framework and delegates the day-to-day implementation of this framework to the AIG Treasurer. Our corporate treasury function manages liquidity risk, subject to ERM oversight and various control processes.
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.
Comprehensive cash flow projections under normal conditions are the primary component for identifying and measuring liquidity risk. We produce comprehensive liquidity projections over varying time horizons that incorporate all relevant liquidity sources and uses and include known and likely cash inflows and outflows. In addition, we perform stress testing by identifying liquidity stress scenarios and assessing the effects of these scenarios on our cash flow and liquidity.
Coverage Ratios measure the adequacy of available liquidity sources, including the ability to monetize assets to meet the forecasted cash flows over a specified time horizon. The portfolio of assets is selected based on our ability to convert those assets into cash under the assumed market conditions and within the specified time horizon.
Operational risk is overseen at the corporate level within ERM through the Head of AIG Operational and Technology Controls, who reports directly to our CRO. The Head of AIG Operational and Technology Controls is responsible for the development and maintenance of the operational risk framework that includes policies, standards and deployment of systems.
responsibilities, and the third line consists of our Internal Audit Group that provides independent assurance covering aspects of the First and Second Lines of Defense, in each case, to strengthen the governance, capability and delivery of operational risk management tools and methods. A key area of ongoing development is to have business leaders assume ownership and accountability for the risks and controls in their operating units, including support functions, for the operational risks that arise in their own processes and activities. In line with the Three Lines of Defense Model, the ORM programs include, but are not limited to, several key components outlined below:
• Issues Management - enables a consistent tracking of issues across the firm, including policy and process exceptions, control deficiencies and findings from risk and control assessment activities.
• Scenario Analyses - executed by first- and second-line professionals to identify potential risks that could result in financial losses in order to identify the financial implications of the risk to the firm and support the prioritization of operational risk treatment.
• foster greater consistency in identifying, measuring and ranking material risks;
Except as described above, we manage our business risk oversight activities through our insurance operations. A primary goal in managing our insurance operations is to achieve an acceptable risk-adjusted return on equity. To achieve this goal, we must be disciplined in risk selection, premium adequacy, and appropriate terms and conditions to cover the risk accepted.
• Life and Retirement companies - risks include mortality and morbidity in the insurance-oriented products and insufficient cash flows to cover contract liabilities and longevity risk in the retirement savings-oriented products. We manage risks through product design, sound medical and non-medical underwriting, and external reinsurance programs.
We manage our risks through risk review and selection processes, exposure limitations, exclusions, deductibles, self-insured retentions, coverage limits, attachment points, and reinsurance. This management is supported by sound underwriting practices, pricing procedures and the use of actuarial analysis to help determine overall adequacy of provisions for insurance. Underwriting practices and pricing procedures incorporate historical experience, changes in underlying exposure, current regulation and judicial decisions as well as proposed or anticipated regulatory changes.
• Loss Reserves - The potential inadequacy of the liabilities we establish for unpaid losses and loss adjustment expenses is a key risk faced by the General Insurance companies. There is significant uncertainty in factors that may drive the ultimate development of losses compared to our estimates of losses and loss adjustment expenses. We manage this uncertainty through internal controls and oversight of the loss reserve setting process, as well as reviews by external experts. For further information see Critical Accounting Estimates - Insurance Liabilities - Loss Reserves herein.
• Underwriting - The potential inadequacy of premiums charged for future risk periods on risks underwritten in our portfolios can impact the General 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 unexpected or increased costs or expenses.
• Catastrophe Exposure - Our business is exposed to various catastrophic events in which multiple losses can occur and affect multiple lines of business in any calendar year. Natural disasters, such as hurricanes, earthquakes and other catastrophes, have the potential to adversely affect our operating results. Other risks, such as man-made catastrophes or pandemic disease, could also adversely affect our business and operating results to the extent they are covered by our insurance products. Concentration of exposure in certain industries or geographies may cause us to suffer disproportionate losses.
We use third-party catastrophe risk models and other tools to evaluate and simulate frequency and severity of catastrophic events and associated losses to our portfolios of exposures. We apply a proprietary multi-model approach to account for relative strengths and weaknesses of vendor models, and make adjustments to modeled losses to account for loss adjustment expenses, model biases, data quality and non-modeled risks.
(d) Taxed at statutory rate of 21 percent and 30 percent for the U.S. and Japanese modeled losses, respectively.
The OEP estimates provided above reflect our in-force portfolios at September 30, 2017, for both U.S. and Japan exposures. The catastrophe reinsurance program is as of January 1, 2018.
Our 2018 catastrophe reinsurance program provides protection on both an aggregate and occurrence basis with respect to North American exposures including United States, Canada, Mexico and the Caribbean.
• Aggregate protection protects us against a high frequency of losses from certain events including windstorm, severe convective storm, earthquake, wildfire, and flood. Under this part of the program, AIG can recover up to $2.75 billion of aggregate losses in excess of $750 million. The event deductible is $100 million initially, but increases to $250 million for individual events greater than $750 million after the $750 million aggregate retention is exhausted. This protection will also cover a large event, providing coverage of up to $2 billion after the aggregate retention of $750 million is exhausted.
• Occurrence protection is provided primarily on a $2 billion excess of $2 billion basis, with one reinstatement, with an additional $750 million excess of $4 billion on top of that but with no reinstatement. The $750 million excess of $4 billion layer is shared with the top $750 million layer of aggregate protections, such that, only a total of $750 million of limit is available across those two layers.
• Longevity risk - represents the risk of a change in value of a policy or benefit as a result of 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 pension risk transfer, structured settlement, and annuity products.
• Mortality risk - represents the risk of loss arising from actual mortality rates being higher than expected mortality rates. This risk could arise from pandemics or other events, including longer-term societal changes that cause higher-than-expected mortality. This risk exists in a number of our product lines, but is most significant for our life insurance products.
The emergence of significant adverse experience compared to the initial assumptions at policy issuance or updated assumption would require an adjustment to DAC and benefit reserves, which could have a material adverse effect on our consolidated results of operations for a particular period.
Our Individual and Group Retirement businesses offer variable annuity products with GMWB riders that guarantee a certain level of benefits. GMWB guaranteed living benefits are accounted for as embedded derivatives measured at fair value, with changes in the fair value recorded in Other realized capital gains (losses). GMWB features subject the Life and Retirement companies to market risk, including exposure to changes in interest rates, equity prices, credit spreads and market volatility.
For index annuity and universal life products, we have a hedging program designed to manage the index crediting strategies associated with index annuity and index life products. This hedging program is designed to offset the economic risk with respect to the index returns for the current crediting rate reset period, and utilizes derivative instruments, including but not limited to equity index options and futures contracts. Similarly as with the variable annuities, there are differences between the calculation of the economic hedge target and U.S. GAAP valuation of the index annuity and index life embedded derivatives, which can lead to variances in their relative movements.
Our hedging programs utilize various derivative instruments, including but not limited to equity options, futures contracts, interest rate swaps and swaption contracts, as well as other hedging instruments. In addition, for variable annuities, we purchase certain fixed income securities and elect the fair value option as a capital efficient way to manage interest rate and credit spread exposures. To
• non-proportional or excess of loss reinsurance, whereby we cede all or a specified portion of losses in excess of a specified amount on a per risk, per occurrence (including catastrophe reinsurance) or aggregate basis; or
• Paid losses recoverable - balances due from reinsurers for losses and loss adjustment expenses paid by our subsidiaries and billed, but not yet collected.
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 sets limits with regard to the amount and type of 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 relevant risk-based capital (RBC) ratios fall below certain levels. We also set maximum limits for reinsurance recoverable exposure, which in some cases is the recoverable amount plus an estimate of the maximum potential exposure from unexpected events for a reinsurer. In addition, credit executives within ERM review reinsurer exposures and credit limits and approve reinsurer credit limits above specified levels. Finally, even where we conclude that uncollateralized credit risk is acceptable, we require collateral from active reinsurance counterparties where it is necessary for our subsidiaries to recognize the reinsurance recoverable assets for statutory accounting purposes. At December 31, 2017, we held $20.5 billion of collateral, in the form of funds withheld, securities in reinsurance trust accounts and/or irrevocable letters of credit, in support of reinsurance recoverable assets from unaffiliated reinsurers. We believe that no exposure to a single reinsurer represents an inappropriate concentration of risk to AIG, nor is our business substantially dependent upon any single reinsurance contract.
(d) Includes $13.2 billion recoverable under the 2011 retroactive asbestos reinsurance transaction and the 2017 Adverse Development Reinsurance agreement.
DAC Related to Unrealized Appreciation (Depreciation) of Investments An adjustment to DAC and Reserves for investment-oriented products, equal to the change in DAC and Unearned Revenue amortization that would have been recorded if fixed maturity and equity securities available for sale had been sold at their stated aggregate fair value and the proceeds reinvested at current yields. An adjustment to benefit reserves for investment-oriented products is also recognized to reflect the application of the benefit ratio to the accumulated assessments that would have been recorded if fixed maturity and equity securities available for sale had been sold at their stated aggregate fair value and the proceeds reinvested at current yields (collectively referred to as “shadow Investment-Oriented Adjustments”).
For long-duration traditional products, significant unrealized appreciation of investments in a sustained low interest rate environment may cause additional future policy benefit liabilities to be recorded (shadow loss reserves).
Loss Ratio Losses and loss adjustment expenses incurred divided by net premiums earned.
Natural catastrophe and man-made losses are generally weather or seismic events having a net impact on AIG in excess of $10 million each and also include certain man-made events, such as terrorism and civil disorders that meet the $10 million threshold.
Policy fees An amount added to a policy premium, or deducted from a policy cash value or contract holder account, to reflect the cost of issuing a policy, establishing the required records, sending premium notices and other related expenses.
Premiums and deposits - Life and Retirement include direct and assumed amounts received on traditional life insurance policies and group benefit policies, and deposits on life-contingent payout annuities, as well as deposits received on universal life, investment-type annuity contracts and mutual funds.
Supplementary Insurance Information at December 31, 2017, 2016 and 2015 and for the years then ended
Reinsurance at December 31, 2017, 2016 and 2015 and for the years then ended
Valuation and Qualifying Accounts at December 31, 2017, 2016 and 2015 and for the years then ended
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control over Financial Reporting appearing under Item 9A in the Annual Report on the Form 10-K. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
Bonds available for sale, at fair value (amortized cost: 2017 - $225,461; 2016 - $232,241)
Mortgage and other loans receivable, net of allowance (portion measured at fair value: 2017 - $5; 2016 - $11)
Short-term investments (portion measured at fair value: 2017 - $2,615; 2016 - $3,341)
Policyholder contract deposits (portion measured at fair value: 2017 - $4,150; 2016 - $3,058)
Long-term debt (portion measured at fair value: 2017 - $2,888; 2016 - $3,428)
Common stock, $2.50 par value; 5,000,000,000 shares authorized; shares issued: 2017 - 1,906,671,492 and
Treasury stock, at cost; 2017 - 1,007,626,835; 2016 - 911,335,651 shares of common stock
Net gains on sales of securities available for sale and other assets
ITEM 8 | Notes to Consolidated Financial Statements | 1. Basis of Presentation
On August 31, 2016, we sold our controlling interest in NSM Insurance Group LLC (NSM), a managing general agent to ABRY Partners, a private equity firm, for consideration of $201 million resulting in a pre-tax gain of approximately $105 million in the third quarter of 2016. We retained an equity interest in a newly formed joint venture and will continue to provide underwriting capacity to NSM.
• fair value measurements of certain financial assets and liabilities; and
For the year ended December 31, 2016, we recorded out of period adjustments relating to prior years that increased Net loss attributable to AIG by $174 million, increased Loss from continuing operations before income taxes by $57 million and decreased adjusted pre-tax income by $6 million. The out of period adjustments are primarily related to income tax liabilities and ceded loss adjustment expenses. Had these adjustments, which were determined not to be material, been recorded in their appropriate periods, Net Income attributable to AIG for the years ended December 31, 2015 and 2014 would have decreased by $67 million and $12 million, respectively.
For the year ended December 31, 2015, we recorded out of period adjustments relating to prior years that decreased Net income attributable to AIG by $156 million, decreased Income from continuing operations before income taxes by $376 million and decreased adjusted pre-tax income by $235 million. The out of period adjustments are primarily related to impairments of Other invested assets
Other income includes advisory fee income from the Life and Retirement broker dealer business, as well as legal recoveries of $27 million, $44 million and $94 million from legacy crisis and other matters in 2017, 2016 and 2015, respectively.
· 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 earnings distributions from other investments.
· Earnings from private equity funds and hedge fund investments accounted for under the equity method.
Short-term investments consist of interest-bearing cash equivalents, time deposits, securities purchased under agreements to resell, and investments, such as commercial paper, with original maturities within one year from the date of purchase.
Premiums and other receivables - net of allowance include premium balances receivable, amounts due from agents and brokers and policyholders, trade receivables for the Direct Investment book (DIB) and Global Capital Markets (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 $236 million and $279 million at December 31, 2017 and 2016, respectively.
Other assets consist of sales inducement assets, prepaid expenses, deposits, other deferred charges, real estate, other fixed assets, capitalized software costs, goodwill, intangible assets other than goodwill, restricted cash and derivative assets.
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 $738 million and $808 million at December 31, 2017 and 2016, 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 $94 million, $77 million and $88 million for the years ended December 31, 2017, 2016 and 2015, respectively.
payables to counterparties that relate to unrealized gains and losses on futures, forwards, and options and balances due to clearing brokers and exchanges. Trade payables for GCM also include cash collateral received from derivative counterparties that contractually cannot be netted against derivative assets.
In March 2016, the Financial Accounting Standards Board (FASB) issued an accounting standard that clarifies that a change in the counterparty (novation) to a derivative instrument that has been designated as a hedging instrument does not, in and of itself, require de-designation of that hedging relationship provided that all other hedge accounting criteria continue to be met.
In March 2016, the FASB issued an accounting standard that eliminates the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods during which the investment had been held.
We adopted the standard on its required effective date of January 1, 2017. The adoption of this standard did not have a material effect on our consolidated financial condition, results of operations or cash flows.
In January 2016, the FASB issued an accounting standard that will require equity investments that do not follow the equity method of accounting or are not subject to consolidation to be measured at fair value with changes in fair value recognized in earnings, while financial liabilities for which fair value option accounting has been elected, changes in fair value due to instrument-specific credit risk will be presented separately in other comprehensive income. The standard allows the election to record equity investments without readily determinable fair values at cost, less impairment, adjusted for subsequent observable price changes with changes in the carrying value of the equity investments recorded in earnings. The standard also updates certain fair value disclosure requirements for financial instruments carried at amortized cost.
We plan to adopt the standard on its effective date of January 1, 2019 using a modified retrospective approach upon adoption. We are currently quantifying the expected recognition on our balance sheet for a right to use asset and a lease liability as required by the standard. We do not expect the impact of the standard to have a material effect on our reported consolidated financial condition, results of operations, cash flows or required disclosures.
In June 2016, the FASB issued an accounting standard that will change how entities account for credit losses for most financial assets, trade receivables and reinsurance receivables. The standard will replace the existing incurred loss impairment model with a new “current expected credit loss model” that generally will result in earlier recognition of credit losses. The standard will apply to financial assets subject to credit losses, including loans measured at amortized cost, reinsurance receivables and certain off-balance sheet credit exposures. Additionally, the impairment of available-for-sale debt securities, including purchased credit deteriorated securities, are subject to the new guidance and will be measured in a similar manner, except that losses will be recognized as allowances rather than reductions in the amortized cost of the securities. The standard will also require additional information to be disclosed in the footnotes.
In August 2016, the FASB issued an accounting standard that addresses diversity in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments provide clarity on the treatment of eight specifically defined types of cash inflows and outflows.
We will adopt this standard retrospectively on its effective date of January 1, 2018. The standard addresses presentation in the statement of cash flows only and will have no effect on our reported consolidated financial condition, results of operations or required disclosures.
We will adopt the standard retrospectively on its effective date of January 1, 2018. The standard addresses presentation of restricted cash in the Statement of Cash Flows only and will have no effect on our reported consolidated financial condition, results of operations or required disclosures.
The standard is effective on January 1, 2020, with early adoption permitted. We are evaluating the timing of our adoption. Any impact of the standard will be dependent on the market conditions of the reporting units at the time of adoption.
In February 2017, the FASB issued an accounting standard that clarifies the scope of the derecognition guidance for the sale, transfer and derecognition of non-financial assets to noncustomers that aligns with the new revenue recognition principles. The standard also adds new accounting for partial sales of nonfinancial assets (including in substance real estate) that requires an entity to derecognize a nonfinancial asset when it 1) ceases to have a controlling financial interest in the legal entity that holds the asset based on the consolidation model and 2) transfers control of the asset based on the revenue recognition model.
In March 2017, the FASB issued an accounting standard that shortens the amortization period for certain callable debt securities held at a premium by requiring the premium to be amortized to the earliest call date. The standard does not require an accounting change for securities held at a discount, which continue to be amortized to maturity.
We plan to adopt the standard retrospectively on its effective date, January 1, 2019. We do not expect the standard to have a material impact on our reported consolidated financial condition, results of operations, cash flows or required disclosures.
In May 2017, the FASB issued an accounting standard that provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting.
We will prospectively adopt this standard on its effective date of January 1, 2018 and do not expect the standard to have a material effect on our reported consolidated financial condition, results of operations, cash flows or required disclosures.
- Commercial Lines - consists of Liability, Financial Lines, Property and Special Risks.
· Life Insurance - primary products in the U.S. include term life and universal life insurance. International operations include distribution of life and health products in the UK and Ireland.
Investment income of the General Insurance companies is attributed to the North America and International operating segments based on an internal investment income allocation model. The model estimates investable funds based primarily on loss reserves and unearned premiums. Investment income of the Life and Retirement companies is attributed to the Individual Retirement, Group Retirement, Life Insurance and Institutional Markets operating segments as well as the Legacy Life and Retirement Run-Off Lines based on invested assets in segregated product line portfolios; income from invested assets in excess of liabilities is allocated to product lines based on internal capital estimates.
The following table presents AIG’s year-end identifiable assets and capital expenditures by legal entity category:
At December 31, 2017, we had no businesses classified as held-for-sale. At December 31, 2016, the following businesses were reported as held-for-sale:
On August 15, 2016, we entered into a definitive agreement to sell our 100 percent interest in United Guaranty and certain related affiliates to Arch. This transaction closed on December 31, 2016 and we received proceeds of approximately $3.3 billion, consisting of $2.2 billion of cash, and approximately $1.1 billion of newly issued Arch convertible non-voting common-equivalent preferred stock. We also received $261 million in pre-closing dividends from United Guaranty in the fourth quarter of 2016. However, due to pending regulatory approvals, United Guaranty Asia was not included in the December 31, 2016 closing and $40 million of cash consideration was retained by Arch. The sale of United Guaranty Asia was completed on July 1, 2017 and we received the $40 million cash proceeds.
On October 18, 2016, we entered into agreements to sell certain insurance operations to Fairfax Financial Holdings Limited (Fairfax). The agreements include the sale of our subsidiary operations in Argentina, Chile, Colombia, Uruguay, Venezuela and Turkey. Fairfax will also acquire renewal rights for the portfolios of local business written by our operations in Bulgaria, the Czech Republic, Hungary, Poland, Romania and Slovakia, and assume certain of our operating assets and employees. Total cash consideration to us is expected to be approximately $234 million. The transaction is closing on a country-by-country basis as the regulatory approvals are obtained. In the second quarter of 2017, the sale of operations in Turkey as well as the renewal rights in Bulgaria, the Czech Republic, Hungary, Poland and Slovakia were completed, which resulted in total cash proceeds of $48 million. In the third quarter of 2017, the sale of the operations in Colombia, Chile and Argentina were completed, which resulted in cash proceeds of $168 million. Substantially all of the operations and renewal rights that we agreed to sell Fairfax were sold by December 31, 2017.
Assets and liabilities recorded at fair value in the Consolidated Balance Sheets are measured and classified in accordance with a fair value hierarchy consisting of three “levels” based on the observability of valuation inputs:
• Level 2: Fair value measurements based on inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.
We estimate the fair value of mortgage and other loans receivable that are measured at fair value by using dealer quotations, discounted cash flow analyses and/or internal valuation models. The determination of fair value considers inputs such as interest rate, maturity, the borrower’s creditworthiness, collateral, subordination, guarantees, past-due status, yield curves, credit curves, prepayment rates, market pricing for comparable loans and other relevant factors.
Certain variable annuity and equity-indexed annuity and life contracts contain embedded 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 either (i) a written option that guarantees a minimum accumulation value at maturity, (ii) a written option that guarantees annual withdrawals regardless of underlying market performance for a specific period or for life, or (iii) equity-indexed written options that meet the criteria of derivatives and must be bifurcated.
Borrowings under obligations of guaranteed investment agreements (GIAs), which are guaranteed by us, are recorded at fair value using discounted cash flow calculations based on interest rates currently being offered for similar contracts and our current market observable implicit credit spread rates with maturities consistent with those remaining for the contracts being valued. Obligations may be called at various times prior to maturity at the option of the counterparty. Interest rates on these borrowings are primarily fixed, vary by maturity and range up to 7.62 percent.
(a) Excludes investments that are measured at fair value using the net asset value (NAV) per share (or its equivalent), which totaled $6.0 billion and $6.7 billion as of December 31, 2017 and December 31, 2016, respectively.
We record transfers of assets and liabilities into or out of Level 3 classification at their fair values as of the end of each reporting period, consistent with the date of the determination of fair value. The Net realized and unrealized gains (losses) included in income (loss) or Other comprehensive income (loss) as shown in the table above excludes $64 million and $188 million of net losses related to assets and liabilities transferred into Level 3 during 2017 and 2016, respectively, and includes $36 million and $189 million of net losses related to assets and liabilities transferred out of Level 3 during 2017 and 2016, respectively.
There were no significant transfers of derivative or other liabilities into or out of Level 3 for the years ended December 31, 2017 and 2016.
• Long-term equity volatilities represent equity volatility beyond the period for which observable equity volatilities are available. Increases in assumed volatility will generally increase the fair value of both the projected cash flows from rider fees as well as the projected cash flows related to benefit payments. Therefore, the net change in the fair value of the liability may be either a decrease or an increase, depending on the relative changes in projected rider fees and projected benefit payments.
• Base lapse rate assumptions are determined by company experience and are adjusted at the contract level using a dynamic lapse function, which reduces the base lapse rate when the contract is in-the-money (when the contract holder’s guaranteed value, as estimated by the company, is worth more than their underlying account value). Lapse rates are also generally assumed to be lower in periods when a surrender charge applies. Increases in assumed lapse rates will generally decrease the fair value of the liability, as fewer policyholders would persist to collect guaranteed withdrawal amounts.
• Utilization assumptions estimate the timing when policyholders with a GMWB will elect to utilize their benefit and begin taking withdrawals. The assumptions may vary by the type of guarantee, tax-qualified status, the contract’s withdrawal history and the age of the policyholder. Utilization assumptions are based on company experience, which includes partial withdrawal behavior. Increases in assumed utilization rates will generally increase the fair value of the liability.
Debt and/or equity investments made as part of a transaction in which assets of mature companies are acquired from the current shareholders, typically with the use of financial leverage
Private equity fund investments included above are not redeemable, because 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, 2017, assuming average original expected lives of 10 years for the funds, 58 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, 17 percent between four and six years and 25 percent between seven and 10 years.
The hedge fund investments included above, which are carried at fair value, are generally redeemable monthly (22 percent), quarterly (43 percent), semi-annually (12 percent) and annually (23 percent), with redemption notices ranging from one day to 180 days. At December 31, 2017, investments representing approximately 49 percent of the total fair value of these hedge fund investments had partial contractual redemption restrictions. These partial redemption restrictions are generally related to one or more investments held in the hedge funds that the fund manager deemed to be illiquid. 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. The majority of these restrictions are generally expected to be lifted by the end of 2018.
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.
Additionally, we elect the fair value option for certain alternative investments when such investments are eligible for this election. We believe this measurement basis is consistent with the applicable accounting guidance used by the respective investment company funds themselves.
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, 2017 or 2016.
• Impairments for Other investments for the period ended December 31, 2015 primarily relate to certain investments in affordable housing partnerships, the fair values of which are determined based on remaining tax credits and other residual benefits due from the respective partnerships. Residual benefits include consideration of the fair value of underlying real estate properties, which is determined based on market-appropriate capitalization rates applied to net operating income of the properties. Impairments for Other investments for the period ended December 31, 2016 primarily relate to certain investments in aircraft, the fair values of which are determined based on third-party independent appraisals that use industry specific appraisal standards and methodologies. Impairments for Other investments for the period ended December 31, 2017 primarily relate to commercial mortgage loans, the fair values of which are determined based on independent broker quotations or valuation models using unobservable inputs, as well as the estimated fair value of the underlying collateral or the present value of the expected future cash flows. The rest of the impairments relate to real estate investments, the fair values of which are determined based on third-party independent appraisals or discounted cash-flow models, as well as certain investments in aircraft, the fair values of which are determined based on third-party independent appraisals that use industry-specific appraisal standards and methodologies.
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, 2017 or 2016.
The following table presents the amortized cost or cost and fair value of our available for sale securities:
For the years ended December 31, 2017, 2016 and 2015, the aggregate fair value of available for sale securities sold was $31.3 billion, $30.2 billion and $28.7 billion, which resulted in net realized capital gains of $0.5 billion, $1.1 billion and $1.1 billion, respectively.
* Includes $251 million and $421 million of U.S. government agency backed ABS at December 31, 2017 and 2016, respectively.
(b) Approximately 75 percent of our hedge fund portfolio is available for redemption in 2018, an additional 25 percent will be available between 2019 and 2024.
(c) Net of accumulated depreciation of $515 million and $451 million in 2017 and 2016, respectively.
During 2017, 2016 and 2015, income recognized on investments in life settlements was $266 million, $453 million and $332 million, respectively, and is included in Net investment income in the Consolidated Statements of Income. We sold the remaining portion of our life settlements portfolio in 2017.
• Interest income and related expenses, including amortization of premiums and accretion of discounts with changes in the timing and the amount of expected principal and interest cash flows reflected in yield, as applicable.
* Includes income from hedge funds, private equity funds and affordable housing partnerships. Hedge funds for which we elected the fair value option are recorded as of the balance sheet date. Other hedge funds are generally reported on a one-month lag, while private equity funds are generally reported on a one-quarter lag.
(a) In 2016 and 2015 includes realized gains on the sale of a portion of our holdings in People’s Insurance Company (Group) of China Limited and PICC Property & Casualty Company Limited (collectively, our PICC Investment).
* Excludes net unrealized gains (losses) attributable to businesses held for sale.
Our investments in life settlements are monitored for impairment on a contract-by-contract basis quarterly. An investment in life settlements is considered impaired if the undiscounted cash flows resulting from the expected proceeds would not be sufficient to recover our estimated future carrying amount, which is the current carrying amount for the investment in life settlements plus anticipated undiscounted future premiums and other capitalizable future costs, if any. Impaired investments in life settlements are written down to their estimated fair value which is determined on a discounted cash flow basis, incorporating current market mortality assumptions and market yields or by repricing to the anticipated sale price as appropriate.
We enter into secured financing transactions whereby certain securities are sold under agreements to repurchase (repurchase agreements), in which we transfer securities in exchange for cash, with an agreement by us to repurchase the same or substantially similar securities. Our secured financing transactions also include those that involve the transfer of securities to financial institutions in exchange for cash (securities lending agreements). In all of these secured financing transactions, the securities transferred by us (pledged collateral) may be sold or repledged by the counterparties. These agreements are recorded at their contracted amounts plus accrued interest, other than those that are accounted for at fair value.
At December 31, 2017 and 2016, amounts borrowed under repurchase and securities lending agreements totaled $4.5 billion and $4.2 billion, respectively.
At December 31, 2017 and December 31, 2016, amounts loaned under reverse repurchase agreements totaled $2.2 billion and $1.4 billion, respectively.
Investments held in escrow accounts or otherwise subject to restriction as to their use were $255 million and $523 million, comprised of bonds available for sale and short term investments at December 31, 2017 and 2016, respectively.
A significant majority of commercial mortgages in the portfolio are non-recourse loans and, accordingly, the only guarantees are for specific items that are exceptions to the non-recourse provisions. It is therefore extremely rare for us to have cause to enforce the provisions of a guarantee on a commercial real estate or mortgage loan.
* Of the total allowance at the end of the year, $5 million, $11 million and $24 million relates to individually assessed credit losses on $82 million, $280 million and $507 million of commercial mortgages as of December 31, 2017, 2016 and 2015, respectively.
During the 12 month period ended December 31, 2017, loans with a carrying value of $237 million were modified in troubled debt restructurings. Loans that had been modified in troubled debt restructurings during the 12 month period ended December 31, 2016 have been fully paid off.
In the ordinary course of business, our insurance companies may use both treaty and facultative reinsurance to minimize their net loss exposure to any single catastrophic loss event or to an accumulation of losses from a number of smaller events or to provide greater diversification of our businesses. In addition, our general insurance subsidiaries assume reinsurance from other insurance companies. We determine the portion of the incurred but not reported (IBNR) loss that will be recoverable under our reinsurance contracts by reference to the terms of the reinsurance protection purchased. This determination is necessarily based on the estimate of IBNR and accordingly, is subject to the same uncertainties as the estimate of IBNR. Reinsurance assets include the balances due from reinsurance and insurance companies under the terms of our reinsurance agreements for paid and unpaid losses and loss adjustment expenses incurred, ceded unearned premiums and ceded future policy benefits for life and accident and health insurance contracts and benefits paid and unpaid. Amounts related to paid and unpaid losses and benefits and loss expenses with respect to these reinsurance agreements are substantially collateralized. We remain liable to the extent that our reinsurers do not meet their obligation under the reinsurance contracts, and as such, we regularly evaluate the financial condition of our reinsurers and monitor concentration of our credit risk. The estimation of the allowance for doubtful accounts requires judgment for which key inputs typically include historical trends regarding uncollectible balances, disputes and credit events as well as specific reviews of balances in dispute or subject to credit impairment. The allowance for doubtful accounts on reinsurance assets was $187 million and $207 million at December 31, 2017 and 2016, respectively. Changes in the allowance for doubtful accounts on reinsurance assets are reflected in Policyholder benefits and losses incurred within the Consolidated Statements of Income.
Retroactive reinsurance agreements are reinsurance agreements under which our reinsurer agrees to reimburse us as a result of past insurable events. For these agreements, the excess of the amounts ultimately collectible under the agreement over the consideration paid is recognized as a deferred gain liability and amortized into income over the settlement period of the ceded reserves. The amount of the deferral is recalculated each period based on loss payments and updated estimates. If the consideration paid exceeds the ultimate losses collectible under the agreement, the net loss on the agreement is recognized in income immediately. Ceded loss reserves under retroactive agreements were $13.4 billion and $1.7 billion, and the deferred gain liability was $1.6 billion and $384 million, as of December 31, 2017 and 2016, respectively. The effect on income from amortization of the deferred gain was $316 million, $30 million and $8 million for the years ended December 31, 2017, 2016, and 2015, respectively.
In 2017, we entered into a retroactive reinsurance agreement with National Indemnity Company (NICO), a subsidiary of Berkshire Hathaway Inc. (Berkshire), under which we transferred to NICO 80 percent of the reserve risk on substantially all of our U.S. commercial long-tail exposures for accident years 2015 and prior. Under this agreement, we ceded to NICO 80 percent of the paid losses on subject business paid on or after January 1, 2016 in excess of $25 billion of net paid losses, up to an aggregate limit of $25 billion. At NICO’s 80 percent share, NICO’s limit of liability under the contract is $20 billion. The covered losses ceded to NICO were
Long-duration insurance in-force assumed as a percentage of gross long-duration insurance in-force was 0.03 percent at both December 31, 2017 and 2016, and 0.04 percent at December 31, 2015; and premiums assumed represented 5 percent, 3 percent and 0.1 percent of gross premiums for the years ended December 31, 2017, 2016 and 2015, respectively.
Our third-party reinsurance arrangements do not relieve us from our direct obligations to our beneficiaries. Thus, a credit exposure exists with respect to both short-duration and long-duration reinsurance ceded to the extent that any reinsurer fails to meet the obligations assumed under any reinsurance agreement. We hold substantial collateral as security under related reinsurance agreements in the form of funds, securities, and/or letters of credit. A provision has been recorded for estimated unrecoverable reinsurance. We believe that no exposure to a single reinsurer represents an inappropriate concentration of credit risk to AIG. Gross reinsurance assets due from reinsurers exceeding 5 percent of our total reinsurance assets were approximately $18 billion and $8.2 billion at December 31, 2017 and 2016, respectively, of which approximately $7.6 billion and $4.4 billion at December 31, 2017 and 2016, respectively, was not secured by collateral.
To estimate future estimated gross profits for variable annuity products, a long-term annual asset growth assumption is applied to determine the future growth in assets and related asset-based fees. In determining the asset growth rate, the effect of short-term fluctuations in the equity markets is partially mitigated through the use of a “reversion to the mean” methodology whereby short-term
* Net of reductions in DAC of $1.3 billion, $842 million, and $583 million at December 31, 2017, 2016 and 2015, 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, 2017 expected to be amortized in 2018 through 2022 by year is: 8.4 percent, 7.8 percent, 7.2 percent, 6.1 percent and 5.9 percent, respectively, with 64.6 percent being amortized after five years. These projections are based on current estimates for investment income and spreads, persistency, mortality and morbidity assumptions.
(a) Comprised primarily of Short-term investments and Other assets at December 31, 2017 and 2016.
(b) At December 31, 2017 and 2016, $9.8 billion and $11.7 billion, respectively, of our total unconsolidated VIE assets were recorded as Other invested assets.
(c) These amounts represent our estimate of the maximum exposure to loss under certain insurance policies issued to VIEs if a hypothetical loss occurred to the extent of the full amount of the insured value. Our insurance policies cover defined risks and our estimate of liability is included in our insurance reserves on the balance sheet.
(f) Freestanding derivatives only, excludes Embedded derivatives. Derivative instrument assets and liabilities are recorded in Other Assets and Liabilities, respectively. Fair value of assets related to bifurcated Embedded derivatives was zero at both December 31, 2017 and December 31, 2016. Fair value of liabilities related to bifurcated Embedded derivatives was $4.1 billion and $3.1 billion, respectively, at December 31, 2017 and December 31, 2016. A bifurcated Embedded derivative is generally presented with the host contract in the Consolidated Balance Sheets. Embedded derivatives are primarily related to guarantee features in variable annuity products, which include equity and interest rate components.
We engage in derivative transactions that are not subject to a clearing requirement directly with unaffiliated third parties, in most cases, under International Swaps and Derivatives Association, Inc. (ISDA) Master Agreements. Many of the ISDA Master Agreements also include Credit Support Annex (CSA) provisions, which provide for collateral postings that may vary at various ratings and threshold levels. We attempt to reduce our risk with certain counterparties by entering into agreements that enable collateral to be obtained from a counterparty on an upfront or contingent basis. We minimize the risk that counterparties might be unable to fulfill their contractual obligations by monitoring counterparty credit exposure and collateral value and generally requiring additional collateral to be posted upon the occurrence of certain events or circumstances. In addition, certain derivative transactions have provisions that require collateral to be posted upon a downgrade of our long-term debt ratings or give the counterparty the right to terminate the transaction. In the case of some of the derivative transactions, upon a downgrade of our long-term debt ratings, as an alternative to posting collateral and subject to certain conditions, we may assign the transaction to an obligor with higher debt ratings or arrange for a substitute guarantee of our obligations by an obligor with higher debt ratings or take other similar action. The actual amount of collateral required to be posted to counterparties in the event of such downgrades, or the aggregate amount of payments that we could be required to make, depends on market conditions, the fair value of outstanding affected transactions and other factors prevailing at and after the time of the downgrade.
Collateral posted by us to third parties for derivative transactions was $2.9 billion and $4.5 billion at December 31, 2017 and 2016, 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 $1.5 billion at December 31, 2017 and 2016, respectively. In the case of collateral provided to us under derivative transactions that are not subject to clearing, we generally can repledge or resell collateral.
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 governing multiple derivative transactions between two counterparties. The ISDA Master Agreement generally provides for the net settlement of all, or a specified group, of these derivative transactions, as well as transferred collateral, through a single payment, and in a single currency, as applicable. The net settlement provisions apply 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 governed by the ISDA Master Agreement.
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. For net investment hedge relationships where issued debt is used as a hedging instrument, we assess the hedge effectiveness and measure the amount of ineffectiveness based on changes in spot rates. For net investment hedge relationships that use derivatives as hedging instruments, we assess hedge effectiveness and measure hedge ineffectiveness using changes in forward rates. For the years ended December 31, 2017, 2016, and 2015 we recognized gains (losses) of $(106) million, $123 million and $90 million, respectively, included in Change in foreign currency translation adjustment in Other comprehensive income related to the net investment hedge relationships.
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. At December 31, 2017, as a result of the 2017 segment changes, goodwill is reported within our General Insurance business - North America and International operating segments, our Life and Retirement business - Life Insurance operating segment and our Other Operations and Legacy Portfolio operating segments. When a business is transferred
from one reporting unit to another, as occurred as part of the 2017 segment changes, goodwill from the original operating segment is allocated among reporting units based on the fair value of business transferred, relative to business retained by a reporting unit. As a result, at December 31, 2017, $1.3 billion of goodwill was re-allocated to the General Insurance - North America and General Insurance - International operating segments based on their respective fair values.
The impairment assessment involves an option to first assess qualitative factors to determine whether events or circumstances exist that lead to a determination that it is more likely than not that the fair value of an operating segment is less than its carrying amount. If the qualitative assessment is not performed, or after assessing the totality of the events or circumstances, we determine it is more likely than not that the fair value of an operating segment is less than its carrying amount, the impairment assessment involves a two-step process in which a quantitative assessment for potential impairment is performed.
(d) Includes discount on retroactive insurance in the amount of $1.5 billion for the period ended December 31, 2017.
• Higher than expected losses for Europe Casualty and Financial Lines. We observed a significant increase in large claims activity in our Europe long-tail business, with a large proportion emanating from accident year 2016. In addition, we increased our loss reserves as a result of the decision made by the U.K. Ministry of Justice to reduce the discount rate applied to lump-sum bodily injury payouts, known as the Ogden rate.
• In addition we also observed higher than expected losses in Europe property and special risks business driven by unexpected development on various large claims across the property, aviation, marine, and trade credit segments.
• Updated estimates for extra-contractual obligation claims and unallocated loss adjustment expenses.
The loss development tables below include loss development data by major lines of business for the last ten accident years. The drivers of prior year development are discussed following each of the loss development tables. .
The table below presents the reconciliation of the net liability for unpaid losses and loss adjustment expenses in the following tables to Loss Reserves in the Consolidated Balance Sheets for the year ended December 31, 2017:
The following is information about incurred and paid loss developments as of December 31, 2017, net of reinsurance. The cumulative number of reported claims, the total of IBNR liabilities and expected development on reported loss included within the net incurred loss amounts are presented in the following section.
• Cape Cod method: The Cape Cod method is mechanically similar to the Bornhuetter-Ferguson method with the difference being that the Expected Loss Ratio estimates are determined based on a weighting of the loss estimates that come from the Paid/Incurred Development Methods. This method may be more responsive to recent loss trends than the Bornhuetter-Ferguson method.
• change in claims handling philosophy, operating model, processes, and related ongoing enhancements;
• third-party claims reviews that are periodically performed for key classes of claims such as toxic tort, environmental and other complex casualty claims;
• Reinsurance: Our reinsurance program varies by exposure type and may change from year to year. This may affect the comparability of the data presented in our tables. Note that the impact of the Adverse Development Reinsurance Agreement is shown separately. For the lines of business covered by the agreement, an allocation of the loss recoveries to the line of business by accident year is presented separately in the loss tables. The allocation is based on the underlying distribution of the losses subject to the agreement.
• There are limitations that should be considered on the reported claim count data in the tables below, including:
Supplemental Information: The information about incurred and paid loss development for all periods preceding year ended December 31, 2017 and the related historical claims payout percentage disclosure is unaudited and is presented as supplementary information.
During 2016, we recognized $1.9 billion of unfavorable prior year development due to increased tail and loss development factors.
In addition, for workers’ compensation policies with no deductibles (guaranteed cost), we increased our tail factors for the all other states grouping to reflect the latest unfavorable experience in more mature accident years. This change increased the ultimate losses by approximately $440 million in 2016. We also reflected the increasing cost trends for legal and cost containment services, especially in California, as recent trends in this sector have been unfavorable.
Furthermore, in 2016, the Florida Supreme Court issued two separate rulings that have increased the potential liability for workers’ compensation claims in that state by undoing certain aspects of regulations in place since 2003. The Castellanos ruling eliminated statutory caps on claimant attorney fees in certain cases, and the Westphal ruling eliminated the 104-week limitation on temporary total disability benefits. Also in the second quarter, the Florida Court of Appeals issued the Miles decision, declaring unconstitutional certain restrictions on claimant-paid attorney fees. In in the second quarter 2016, we increased our workers’ compensation reserves by $100 million to reflect our estimate of the costs of these rulings on prior years’ claims.
During 2016, we recognized $1.1 billion of unfavorable prior year development driven by continued higher than expected loss emergence due to increased frequency and severity in recent accident years for both automobile and general liability claims. Approximately $250 million of the unfavorable development is attributable to a cohort of commercial automobile claims identified in 2015 which continued to increase in severity in 2016 beyond what was observed or reasonably expected in 2015. The most significant increases in incurred losses were for accident years 2011 and subsequent. In particular, the frequency and severity of loss events for accident years 2011 and subsequent showed a significant step change from accident years 2010 and prior. We therefore gave limited credibility to accident year 2010 and prior in selecting our expected loss ratios for 2011 and subsequent accident years due to this shift in loss patterns that is now more evident and credible after examining 2016 data. As a result of the continued adverse emergence, we have increased our loss trend assumptions for general liability and automobile and increased our expected loss ratios for the most recent four accident years.
During 2015, U.S. Excess Casualty experienced $1.4 billion of unfavorable prior year development largely driven by worse than expected loss emergence reported in 2015. This increase was largely driven by adverse emergence in both general liability and umbrella auto liability, reflecting worsening trends in the number and nature of high severity losses. Approximately $411 million of the unfavorable development is related to automobile liability. Based on the adverse emergence we updated our assumptions about loss severity, loss development patterns and expected loss ratios for the most recent accident years. We have seen an increasing trend in the frequency of high severity claims, especially in the umbrella automobile liability portfolio. We also observed deterioration in certain class action claims that have complex coverage uncertainties and high limits characterized by increases in new claims and/or demands reported in 2015 and progress towards potential settlements, which have further informed our actuarial projections of ultimate losses for these types of claims. These types of claim classes have the longest emergence period within the excess casualty class and can impact multiple accident years, and are therefore inherently more volatile. In addition, we also increased losses associated with bad-faith claims by approximately $120 million reflecting an increase in recent settlements.
In 2017, we recognized $216 million of unfavorable prior year development in Other Casualty primarily as a result of increased loss severity in recent accident years.
U.S. Other Casualty includes general liability, automobile liability, environmental, medical malpractice, and other casualty lines of business. These lines of business are all long-tail in nature and while somewhat diverse in terms of exposures, these lines are often subject to similar trends. These lines are often significantly impacted by the underwriting cycle and external judicial trends. Many of our policies contain risk-sharing features, including high deductibles, self-insured retentions or retrospective rating features, in addition to a traditional insurance component. These risk-sharing programs generally are large and complex, comprising multiple products, years and structures, and are subject to amendment over time.
During 2016, we recognized adverse loss development of $50 million. The key drivers of this activity were adverse development on liabilities related to commuted and insolvent reinsurers, environmental impairment liability business, and extra-contractual obligations, partially offset by favorable development on loss-sensitive casualty business, residual market business, and reserves for unallocated loss adjustment expenses.
During 2015, we recognized adverse loss development of $514 million. This was primarily related to an increase in estimated liabilities related to our loss-sensitive casualty business.
During 2016, we recognized $306 million of unfavorable prior year development in U.S. Financial Lines primarily due to higher than expected settlements on large claims from the financial crisis.
We generally use a combination of loss development methods and expected loss ratio methods for D&O, E&O, EPLI, and professional liability. These product lines generally are offered on a claims-made basis, and losses are characterized by low frequency and high severity. In general, expected loss ratio methods are given more weight in the more recent accident years, and loss development methods are given more weight in more mature accident years. The loss development factors for the different segments differ significantly in some cases, based on specific coverage characteristics and other factors such as industry group, attachment points, and limits offered. Individual claims projections for accident years ended over eighteen months prior are also used in the analysis.
During 2016, we recognized $396 million of unfavorable prior year development in U.S. Property and Special Risks. The increase was mainly due to the U.S. program product line which is a collection of programs offering package policies to small and middle market insureds.
U.S. Property products include commercial, industrial and energy-related property insurance products and services that cover exposures to manmade and natural disasters, including business interruption. U.S. Special Risk products include aerospace, environmental, political risk, trade credit, surety and marine insurance, and program business for various small and medium sized enterprises insurance lines. The program segments include both property and casualty exposures.
During 2016, we recognized $396 million of unfavorable prior year development driven by our U.S. program business where we recognized $350 million of unfavorable prior year development due to higher than expected claim emergence in certain automobile, habitational and professional liability programs that resulted in our increasing expected loss ratios and loss development factors for several program subsets.
During 2015, we recognized $132 million of favorable prior year development from a number of large individual property claims.
During 2017, we recognized $16 million of unfavorable prior year development in U.S. Personal Insurance mainly due to homeowners business in accident year 2016. This was partially offset by favorable development in accident and health business.
We primarily segment our analysis by line of business and may separately review various sub-segments, such as specific accident and health products and property damage versus liability for personal lines products.
During 2017, we recognized $507 million of unfavorable prior year development in Europe Casualty and Financial Lines driven by continued higher than expected loss emergence.
During 2016, we recognized $320 million of unfavorable prior year development, largely from accident years 2014 and 2015.
We primarily segment our analysis by country and line of business. Additionally, we separately review various product lines, including excess versus primary casualty, commercial versus financial institutions management liability, and other specific programs and subsets of business. We maintain a database of detailed historical premium and loss transactions in original currency for business written outside of the U.S. which allows our actuaries to determine loss reserves without foreign exchange distorting development.
We generally use a combination of loss development methods and expected loss ratio methods. For countries and lines of business with sufficient loss volume, loss development methods may be given significant weight for all but the most recent accident years. For smaller countries and more volatile product lines, loss development methods are typically given limited weight for recent accident years. Further, we may rely on larger data subsets in determining the loss development factors and a priori loss ratio assumptions.
During 2017 we recognized $507 million of unfavorable prior year development in Europe casualty and Financial Lines. We observed a significant increase in large claims activity across multiple segments, notably excess casualty business and D&O and professional liability coverages for financial institutions. This experience was spread across multiple accident years but had the largest impact on accident year 2016 and accident years 2008 and prior. We increased loss development assumptions for Financial Lines business in consideration of the increased loss activity experienced in older accident years and increased expected loss ratios for more recent accident years. For Casualty lines, we increased loadings for large losses, particularly in the more recent accident years. In addition, we increased our loss reserves as a result of the decision made by the U.K. Ministry of Justice to reduce the discount rate applied to lump-sum bodily injury payouts, known as the Ogden rate.
During 2015, we recognized $142 million of unfavorable prior year development, primarily due to primary casualty and professional liability in Continental Europe and the UK. During 2015, we implemented an enhanced claims operating model in Europe which has provided our actuaries with more detailed case reserve data and analysis, enabling AIG’s actuaries to react sooner to case development than in prior years.
Frequency/severity methods, loss development methods, and IBNR factor methods are used alone or in combination to set reserves for short-tail classes such as Europe Property.
We primarily segment our analysis by line of business (and by country for Europe and Japan business) and may separately review various sub-segments, such as specific accident and health products and property damage versus liability for other personal lines products.
In general, development for Europe and Japan Personal Insurance classes has been very stable, with only modest changes in the initial selected loss ratios for this business.
During 2017, 2016 and 2015, we recognized $58 million and $82 million of favorable development, and $15 million of unfavorable development, respectively, mainly driven by the accident and health business.
During 2017, the U.S. Run-Off Long Tail Insurance Lines experienced favorable prior year development of $30 million driven primarily by favorable asbestos development.
Excess workers’ compensation has an extremely long tail and is one of the most challenging lines of business from a reserving perspective, particularly when the excess coverage is provided above a self-insured retention layer. The class is highly sensitive to small changes in assumptions (for example - in the rate of medical inflation or the longevity of injured workers) which can have a significant effect on the ultimate reserve cost estimate.
As noted above, other legacy exposures include environmental impairment liability and related coverages, medical malpractice, workers’ compensation, and general liability. Depending on the individual class or lines of business reviewed, either traditional methods (i.e. paid loss development, incurred loss development), non-traditional methods (such as paid survival ratio or IBNR-to-case ratio methods) or a combination of the two are used. In addition, for some of the environmental impairment liability related coverage,
In 2017, we recognized favorable net prior year development of $37 million on the retained portion of asbestos claims. This was primarily due to additional reinsurance recoveries identified for this portfolio. The development on the portion of the asbestos business ceded to NICO was unfavorable by $50 million on a gross basis, but had no net impact. For environmental, we recognized $22 million in unfavorable prior year development in consideration of activity related to several large clean-up sites and related accounts as well as a result of top-down actuarial analyses performed during the year. As part of this analysis, we increased our estimates of unallocated loss adjustment expense reserves for such claims, which were partially offset by a decrease in indemnity reserves.
We did not recognize any material development in this segment during 2017, 2016 or 2015. The proactive management of settlement negotiations and other claims mitigation strategies minimized the volatility observed during this period.
In 2017, the net prior year development for the remaining legacy was favorable by $15 million. We experienced favorable development on runoff medical malpractice and environmental impairment liability business, which was partially offset by net unfavorable development on other casualty segments.
We increased the reserves for these coverages by $190 million and $636 million during 2016 and 2015, respectively, to reflect updated assumptions about future loss development. The 2016 increase was driven by runoff public entity business where we reacted to the adverse emergence over the last year by increasing our loss development factors to reflect the portfolio’s experience especially in the loss tail instead of relying on the overall excess casualty loss development factors.
* Excludes $173 million and $181 million of discount related to certain long tail liabilities in the United Kingdom at December 31, 2017 and December 31, 2016, respectively.
* Excludes $8 million and $20 million of discount related to certain long tail liabilities in the United Kingdom at December 31, 2017 and 2016, respectively.
During 2017 and 2016, effective interest rates declined due to a decrease in the forward yield curve component of the discount rates reflecting a decline U.S. Treasury rates along the changes in payout pattern assumptions. This resulted in a decrease in the loss reserve discount by $71 million in 2017 and $106 million in 2016.
For universal life policies with secondary guarantees, we recognize certain liabilities in addition to policyholder account balances. For universal life policies with secondary guarantees, as well as other universal life policies for which profits followed by losses are expected at contract inception, a liability is recognized 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 a liability, in addition to policyholder account balances, so that expected future losses are recognized in proportion to the emergence of profits in the earlier (profitable) years. Universal life account balances as well as these additional liabilities related to universal life products are reported within Policyholder contract deposits in the Consolidated Balance Sheet. These additional liabilities are also adjusted to reflect the effect of unrealized gains or losses on fixed maturity and equity securities available for sale on accumulated assessments, with related changes recognized through Other comprehensive income.
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 gross insurance in force at December 31, 2017 and 1.8 percent of gross domestic premiums and other considerations in 2017. The amount of annual dividends to be paid is approved locally by the boards of directors of the Life and Retirement 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.
Certain products are subject to experience adjustments. These include group life and group medical products, credit life contracts, accident and health insurance contracts/riders attached to life policies and, to a limited extent, reinsurance agreements with other direct insurers. Ultimate premiums from these contracts are estimated and recognized as revenue with the unearned portions of the premiums recorded as liabilities in Other policyholder funds. Experience adjustments vary according to the type of contract and the territory in which the policy is in force and are subject to local regulatory guidance.
Variable annuity contracts may include certain contractually guaranteed benefits to the contract holder. These guaranteed features include guaranteed minimum death benefits (GMDB) that are payable in the event of death, and living benefits that are payable in the event of annuitization, or, in other instances, at specified dates during the accumulation period. Living benefits primarily include guaranteed minimum withdrawal benefits (GMWB). A variable annuity contract may include more than one type of guaranteed benefit feature; for example, it may have both a GMDB and a GMWB. However, a policyholder can only receive payout from one guaranteed feature on a contract containing a death benefit and a living benefit, i.e. the features are mutually exclusive (except a surviving spouse who has a rider to potentially collect both a GMDB upon their spouse’s death and a GMWB during their lifetime). A policyholder cannot purchase more than one living benefit on one contract. The net amount at risk for each feature is calculated irrespective of the existence of other features; as a result, the net amount at risk for each feature is not additive to that of other features.
annuity payments equal to the remaining guaranteed amount, and, for lifetime GMWB products, the annuity payments continue as long as the covered person(s) is living.
The liabilities for GMWB, which are recorded in Policyholder contract deposits, are accounted for as embedded derivatives measured at fair value, with changes in the fair value of the liabilities recorded in Other net realized capital gains (losses). The fair value of these embedded derivatives was a net liability of $2.0 billion and $1.8 billion at December 31, 2017 and 2016, respectively.
We had account values subject to GMWB that totaled $45 billion and $41 billion at December 31, 2017 and 2016, respectively. The net amount at risk for GMWB represents the present value of minimum guaranteed withdrawal payments, in accordance with contract terms, in excess of account value, assuming no lapses. The net amount at risk related to the GMWB guarantees was $450 million and $834 million at December 31, 2017 and 2016, respectively. We use derivative instruments and other financial instruments to mitigate a portion of our exposure that arises from GMWB benefits.
The following table presents maturities of long-term debt (including unamortized original issue discount, hedge accounting valuation adjustments and fair value adjustments, when applicable), excluding $6.0 billion in borrowings of debt of consolidated investments:
On July 11, 2013, the AIGLH junior subordinated debentures were distributed to holders of the capital securities, the capital securities were cancelled and the trusts were dissolved. At December 31, 2017, the junior subordinated debentures outstanding consisted of $113 million of 8.5 percent junior subordinated debentures due July 2030, $211 million of 8.125 percent junior subordinated debentures due March 2046 and $37 million of 7.57 percent junior subordinated debentures due December 2045, each guaranteed by AIG Parent.
Additionally, from time to time, various regulatory and governmental agencies review the transactions and practices of AIG and our subsidiaries in connection with industry-wide and other inquiries into, among other matters, the business practices of current and former operating insurance subsidiaries. We have cooperated, and will continue to cooperate, in producing documents and other information in response to such requests.
Consolidated 2008 Securities Litigation. On May 19, 2009, a consolidated class action complaint, resulting from the consolidation of eight purported securities class actions filed between May 2008 and January 2009, was filed against AIG and certain directors and officers of AIG and AIGFP, AIG’s outside auditors, and the underwriters of various securities offerings in the United States District Court for the Southern District of New York (SDNY) in In re American International Group, Inc. 2008 Securities Litigation (the Consolidated 2008 Securities Litigation), asserting claims under the Securities Exchange Act of 1934, as amended (the Exchange Act), and claims under the Securities Act of 1933, as amended (the Securities Act), for allegedly materially false and misleading statements in AIG’s public disclosures from March 16, 2006 to September 16, 2008 relating to, among other things, the Subprime Exposure Issues.
In 2014, lead plaintiff, AIG and AIG’s outside auditor accepted mediators’ proposals to settle the Consolidated 2008 Securities Litigation against all defendants. On October 22, 2014, AIG paid the settlement amount of $960 million. On March 20, 2015, the Court issued an Order and Final Judgment approving the class settlement and dismissing the action with prejudice, and the AIG settlement became final on June 29, 2015.
Individual Securities Litigations. Between November 18, 2011 and February 9, 2015, eleven separate, though similar, securities actions (Individual Securities Litigations) were filed in or transferred to the SDNY, asserting claims substantially similar to those in the Consolidated 2008 Securities Litigation against AIG and certain directors and officers of AIG and AIGFP. Two of the actions were voluntarily dismissed, and the remaining nine have now been settled.
On June 15, 2015, the Court of Federal Claims issued its opinion and order in the SICO Treasury Action. The Court found that the United States exceeded its statutory authority by exacting approximately 80 percent of AIG’s equity in exchange for the FRBNY Credit Facility, but that AIG shareholders suffered no damages as a result. SICO argued during trial that the two classes are entitled to a total of approximately $40 billion in damages, plus interest. The Court also found that the United States was not liable to the Reverse Stock Split Class in connection with the reverse stock split vote at the June 30, 2009 annual meeting of shareholders.
On October 6, 2017, SICO filed a petition for writ of certiorari with the United States Supreme Court.
In the Court of Federal Claims, 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.
from AIG, AIG intends to assert defenses thereto. A reversal of the Court of Federal Claim’s June 17, 2015 decision and judgment and a final determination that the United States is liable for damages, together with a final determination that AIG is obligated to indemnify the United States for any such damages, could have a material adverse effect on our business, consolidated financial condition and results of operations.
Rent expense was $269 million, $331 million and $327 million for the years ended December 31, 2017, 2016 and 2015, respectively.
• For additional disclosures about derivatives see Note 11 to the Consolidated Financial Statements.
The following table presents record date, payment date and dividends paid per share on AIG Common Stock:
(b) In 2017, we repurchased 185,000 warrants to purchase shares of AIG Common Stock.
Our Board of Directors has authorized the repurchase of shares of AIG Common Stock and warrants to purchase shares of AIG Common Stock through a series of actions. On May 3, 2017, our Board of Directors authorized an additional increase of $2.5 billion to its previous share repurchase authorization. As of December 31, 2017, approximately $2.3 billion remained under our share repurchase authorization. Shares may be repurchased from time to time in the open market, private purchases, through forward, derivative, accelerated repurchase or automatic repurchase transactions or otherwise (including through the purchase of warrants). Certain of our share repurchases have been and may from time to time be effected through Exchange Act Rule 10b5-1 repurchase plans.
The basic EPS computation is based on the weighted average number of common shares outstanding, adjusted to reflect all stock dividends and stock splits. The diluted EPS computation is based on those shares used in the basic EPS computation plus shares that would have been outstanding assuming issuance of common shares for all dilutive potential common shares outstanding and adjusted to reflect all stock dividends and stock splits.
(a) Shares in the diluted EPS calculation represent basic shares for 2017 and 2016 due to the net losses in those periods. The shares excluded from the calculation were 22,412,682 shares and 30,326,772 shares for the years ended December 31, 2017 and 2016, respectively.
(b) Dilutive shares included our share-based employee compensation plans and a weighted average portion of the warrants issued to AIG shareholders as part of AIG’s recapitalization in January 2011. The number of shares excluded from diluted shares outstanding were 1.7 million, 0.2 million and 0.2 million for the years ended December 31, 2017, 2016 and 2015, respectively, because the effect of including those shares in the calculation would have been anti-dilutive.
For domestic insurance subsidiaries, aggregate minimum required statutory capital and surplus is based on the greater of the RBC level that would trigger regulatory action or minimum requirements per state insurance regulation. Capital and surplus requirements of our foreign subsidiaries differ from those prescribed in the U.S., and can vary significantly by jurisdiction. At both December 31, 2017 and 2016, all domestic and foreign insurance subsidiaries individually exceeded the minimum required statutory capital and surplus requirements and all domestic insurance subsidiaries individually exceeded RBC minimum required levels.
At December 31, 2017 and 2016, our domestic insurance subsidiaries used the following permitted practices that resulted in reported statutory surplus or risk-based capital that is significantly different from the statutory surplus or risk based capital that would have been reported had NAIC statutory accounting practices or the prescribed regulatory accounting practices of their respective state regulator been followed in all respects:
• In 2015, a domestic life insurance subsidiary domiciled in Texas adopted a permitted statutory accounting practice to report derivatives used to hedge interest rate risk on product-related embedded derivatives at amortized cost instead of fair value. In 2017, the permitted practice was expanded to include additional derivative instruments utilized for the same purpose and to also include an additional domestic life insurance subsidiary domiciled in Texas. This permitted practice resulted in an increase in the statutory surplus of our subsidiaries of $407 million and $645 million at December 31, 2017 and 2016, respectively.
Largely as a result of these restrictions, approximately $44.8 billion of the statutory capital and surplus of our consolidated insurance subsidiaries were restricted from transfer to AIG Parent without prior approval of state insurance regulators at December 31, 2017.
* We recognized $141 million, $105 million and $147 million for immediately vested stock-settled awards issued to retirement eligible employees in 2017, 2016 and 2015, respectively. We also recognized $40 million of excess tax benefits due to share settlements occurring in 2017.
The Company sponsors several Long Term Incentive (LTI) programs under the AIG 2013 Long Term Incentive Plan and its successor plan, the AIG Long Term Incentive Plan (each as applicable, the LTIP), which are governed by the AIG 2013 Omnibus Incentive Plan (Omnibus Plan). The Omnibus Plan replaced the AIG 2010 Stock Incentive Plan (2010 Plan) as of May 15, 2013 but does not affect the terms and conditions of any award issued under the 2010 Plan. The Omnibus Plan is currently the only plan under which share-settled awards can be made. Our share-settled awards are settled with previously acquired shares held in AIG’s treasury.
The value of each award is based on the nature of the performance goals and the price per unit is fixed as of the grant date. PSUs granted in 2017 and 2016 are measured based on AIG’s relative total shareholder return (TSR). PSUs granted in 2015 and 2014 are measured based on AIG’s relative TSR and credit default swap (CDS) spread, weighted 75 percent and 25 percent, respectively. PSUs granted in 2013 are measured based on AIG’s relative TSR and relative growth in tangible book value per common share (TBVPS) (excluding accumulated other comprehensive income) weighted 50 percent each.
The fair value of RSUs as well as PSUs earned based on AIG’s CDS spreads and relative TBVPS was based on the closing price of AIG Common Stock on the grant date. However, PSUs granted in 2014 and 2013 that vest based on these goals were discounted by the present value of estimated dividends to be paid during the respective vesting periods as these awards do not accrue dividends or DEUs. The fair value of PSUs to be earned based on AIG’s relative TSR was determined on the grant date using a Monte Carlo simulation.
(b) The expected volatility is based on the historical volatility of the stock price for the 360 most recent trading days prior to the valuation date estimated by Bloomberg Professional service.
(c) The risk-free interest rate is the continuously compounded interest rate for the term between the valuation date and the end of the performance period that is assumed to be constant and equal to the interpolated value between the closest data points on the U.S. dollar LIBOR-swap curve as of the valuation date.
(a) Excludes stock options and DSUs, which are discussed under Stock Options and Non-Employee Plan, respectively.
(b) Except for the 2013 and 2014 LTI award, PSUs represent target amount granted, and does not reflect potential increases or decreases that could result from the final outcome of the performance goals for the respective awards, which is determined in the quarter after the applicable performance period ends.
The Company issued 2.5 million stock options to two senior executives who joined the Company in 2017. The options vest in installments based on a combination of service requirements of up to three years and/or AIG stock price achieving specified hurdles, and will expire in 2024. The fair value of the options were estimated on the grant date using the Black Scholes model for the time-vesting options, and a Monte Carlo simulation for the hurdle-vesting options using the assumptions noted in the following table.
(b) The expected volatility is the 1080-day implied volatility as seen in the open marketplace on the Valuation Date.
(c) The risk-free interest rate range is 1.76 percent to 2.14 percent.
(d) The contractual term of the option is 7 years from the grant date.
ITEM 8 | Notes to Consolidated Financial Statements | 20. Share-Based Compensation Plans
The following table presents the asset allocation percentage by major asset class for the U.S. qualified plan and the target allocation for 2017 based on the plan’s funded status at December 31, 2017:
The expected long-term rate of return for the plan was 7.0 percent for both 2017 and 2016. The expected rate of return is an aggregation of expected returns within each asset class category, weighted for the investment mix of the assets. The combination of the expected asset return and any contributions made by us are expected to maintain the plan’s ability to meet all required benefit obligations. The expected asset return for each asset class was developed based on an approach that considers key fundamental drivers of the asset class returns in addition to historical returns, current market conditions, asset volatility and the expectations for future market returns.
The following table presents information about our plan assets and indicates the level of the fair value measurement based on the observability of the inputs used. The inputs and methodology used in determining the fair value of these assets are consistent with those used to measure our assets as discussed in Note 5 herein.
(e) Comprised primarily of investments in U.S. asset backed securities and collateralized loan obligations.
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 had no significant concentrations of risks at December 31, 2017.
The U.S. pension plan holds a group annuity contract with U.S. Life, one of our subsidiaries, which totaled $20 million and $21 million at December 31, 2017 and 2016, respectively.
We record transfers of assets into or out of Level 3 at their fair values as of the end of each reporting period, consistent with the date of the determination of fair value. During the year ended December 31, 2017, we had no transfers in or out of Level 3.
Our annual pension contribution in 2018 is expected to be approximately $64 million for our U.S. and non-U.S. pension plans. This estimate is subject to change, since contribution decisions are affected by various factors including our liquidity, market performance and management’s discretion.
We sponsor several defined contribution plans for U.S. employees that provide for pre-tax salary reduction contributions by employees. The most significant plan is the AIG Incentive Savings Plan, for which the matching contribution is 100 percent of the first six percent of a participant’s contributions, subject to the IRS-imposed limitations. Effective January 1, 2016, participants in the AIG Incentive Savings Plan receive an additional fully vested, non-elective, non-discretionary contribution equal to three percent of the participant’s annual base compensation for the plan year, paid each pay period regardless of whether the participant currently contributes to the plan, and subject to the IRS-imposed limitations. Our pre-tax expenses associated with these plans were $209 million, $236 million and $166 million in 2017, 2016 and 2015, respectively.
A Schedule 13G/A filed on February 14, 2018 reports aggregate ownership of 57,556,990 shares, or approximately 6.4 percent (based on the AIG Common Stock outstanding) of AIG Common Stock as of December 31, 2017, by Capital Research Global Investors, a division of Capital Research and Management Company.
A Schedule 13G/A filed on February 8, 2018 reports aggregate ownership of 64,406,363 shares, or approximately 7.2 percent (based on the AIG Common Stock outstanding) of AIG Common Stock as of December 31, 2017, by Blackrock, Inc. and various subsidiaries thereof.
The Tax Act includes provisions for Global Intangible Low-Taxed Income (GILTI) under which taxes on foreign income are imposed on the excess of a deemed return on tangible assets of certain foreign subsidiaries and for Base Erosion and Anti-Abuse Tax (BEAT) under which taxes are imposed on certain base eroding payment to affiliated foreign companies. Consistent with accounting guidance, we will treat BEAT as an in period tax charge when incurred in future periods for which no deferred taxes need to be provided and have made an accounting policy election to treat GILTI taxes in a similar manner. Accordingly, no provision for income taxes related to GILTI or BEAT was recorded as of December 31, 2017.
The Tax Act requires companies to pay a one-time transition tax, net of tax credits related to applicable foreign taxes paid, on previously untaxed current and accumulated earnings and profits (E&P) of certain of our foreign subsidiaries. In the determination of the deemed repatriation tax, we reviewed estimated post-1986 E&P of certain material relevant foreign subsidiaries, and any related non-U.S. income tax paid on such earnings. Based on this analysis, we were able to determine a reasonable estimate and we have recorded a provisional estimate tax benefit of $38 million. While the IRS has issued some guidance on the calculation of the deemed repatriation tax, there are still certain aspects of the calculation that require further clarification. We are continuing to gather additional information to more precisely compute the amount of deemed repatriation tax.
The Tax Act may affect the results in certain investments and partnerships in which we are a non-controlling interest owner. The information needed to determine a provisional estimate is not currently available (such as for interest deduction limitations in those entities and the changed definition of a U.S. Shareholder). Accordingly, no provisional estimates were recorded.
The following table presents income (loss) from continuing operations before income tax expense (benefit) by U.S. and foreign location in which such pre-tax income (loss) was earned or incurred:
For the year ended December 31, 2015, the effective tax rate on income from continuing operations was 32.3 percent. The effective tax rate on income from continuing operations differs from the statutory tax rate of 35 percent primarily due to tax benefits of $195 million associated with tax exempt interest income, $127 million related to reclassifications from accumulated other comprehensive income to income from continuing operations related to the disposal of available for sale securities, $58 million associated with the effect of foreign operations, and $109 million related to the partial completion of the IRS examination covering tax year 2006, partially offset by $324 million of tax charges and related interest associated with increases in uncertain tax positions related to cross border financing transactions, and $110 million related to increases in the deferred tax asset valuation allowances associated with certain foreign jurisdictions.
As a result of the Tax Act, the majority of accumulated foreign earnings that were previously untaxed will become subject to a one-time deemed repatriation tax. Going forward, certain foreign earnings of our foreign affiliates will be exempt from U.S. tax upon repatriation. Notwithstanding the changes, U.S. tax on foreign exchange gain or loss and certain non-U.S. withholding taxes will continue to be applicable upon future repatriations of foreign earnings.
The following table presents our U.S. consolidated income tax group tax losses and credits carryforwards as of December 31, 2017.
* Includes other carryforwards, e.g. general business credits, of $118 million on a U.S. GAAP basis.
In performing our assessment of the recoverability of the deferred tax asset under this framework, we consider tax laws governing the utilization of the net operating loss, capital loss and foreign tax credit carryforwards in each applicable jurisdiction. Under U.S. tax law, a company generally must use its net operating loss carryforwards before it can use its foreign tax credit carryforwards, even though the carryforward period for the foreign tax credit is shorter than for the net operating loss. Our U.S. federal consolidated income tax group includes both life companies and non-life companies. While the U.S. taxable income of our non-life companies can be offset by the net operating loss carryforwards, only a portion (no more than 35 percent) of the U.S. taxable income of our life companies can be offset by those net operating loss carryforwards. The remaining tax liability of our life companies can be offset by the foreign tax credit carryforwards. Accordingly, we utilize both the net operating loss and foreign tax credit carryforwards concurrently which enables us to realize our tax attributes prior to expiration. As of December 31, 2017, based on all available evidence, it is more likely than not that the U.S. net operating loss and foreign tax credit carryforwards will be utilized prior to expiration and, thus, no valuation allowance has been established.
For the year ended December 31, 2017, recent changes in market conditions, including interest rate fluctuations, impacted the unrealized tax gains and losses in the U.S. life insurance companies’ available for sale securities portfolio, resulting in a deferred tax liability related to net unrealized tax capital gains. As of June 30, 2017, based on all available evidence, we concluded that the valuation allowance should be released. As a result, for the six-month period ended June 30, 2017, we released $468 million of valuation allowance associated with the unrealized tax losses in the U.S. life insurance companies’ available for sale securities portfolio, all of which was allocated to other comprehensive income. As of December 31, 2017, we continue to be in an overall unrealized tax gain position with respect to the U.S. life insurance companies’ available for sale securities portfolio and thus concluded no valuation allowance is necessary in the U.S. life insurance companies’ available for sale securities portfolio.
During the year ended December 31, 2017, we recognized a net increase of $43 million in our deferred tax asset valuation allowance associated with certain foreign jurisdictions, primarily attributable to current year activity.
At December 31, 2017 and 2016, we had net deferred tax assets (liabilities) of $366 million and $(164) million, respectively, related to foreign subsidiaries, state and local tax jurisdictions, and certain domestic subsidiaries that file separate tax returns.
At December 31, 2017, 2016 and 2015, our unrecognized tax benefits, excluding interest and penalties, were $4.7 billion, $4.5 billion and $4.3 billion, respectively. The activity for the year includes increases for amounts associated with cross border financing transactions and the impact of settlement discussions with the IRS related to certain other open tax issues unrelated to the cross border financing transactions. With respect to cross border financing transactions, the increase is the result of consideration of recent court decisions upholding the disallowance of foreign tax credits claimed by other corporate entities not affiliated with AIG in addition to the agreement reached in the fourth quarter of 2017 by the parties in the cross border financing dispute to pursue a potential settlement.
At December 31, 2017, 2016 and 2015, our unrecognized tax benefits related to tax positions that, if recognized, would not affect the effective tax rate because they relate to such factors as the timing, rather than the permissibility, of the deduction were $28 million, $66 million and $115 million, respectively. Accordingly, at December 31, 2017, 2016 and 2015, the amounts of unrecognized tax benefits that, if recognized, would favorably affect the effective tax rate were $4.7 billion, $4.4 billion and $4.2 billion, respectively.
ITEM 8 | Notes to Consolidated Financial Statements | 26. Subsequent Events
On February 8, 2018, our Board of Directors declared a cash dividend on AIG Common Stock of $0.32 per share, payable on March 29, 2018 to shareholders of record on March 15, 2018.