• 175 Water Street in New York, New York (Corporate Headquarters; also includes General Insurance companies)
Adjusted pre-tax income is derived by excluding the following items from income from continuing operations before income tax. This definition is consistent across our operating segments. These items generally fall into one or more of the following broad categories: legacy matters having no relevance to our current businesses or operating performance; adjustments to enhance transparency to the underlying economics of transactions; and measures that we believe to be common to the industry. APTI is a GAAP measure for our operating segments.
• Lapse rates, which are based upon actual experience modified to allow for variations in policy form
The following table summarizes the sensitivity of changes in certain assumptions for DAC and SIA, embedded derivatives and other reserves related to guaranteed benefits and URR, measured as the related hypothetical impact on December 31, 2017 balances and the resulting hypothetical impact on pre-tax income, before hedging.
For additional discussion of the Tax Act see Note 23 to the Consolidated Financial Statements.
The increase in pre-tax results was partially offset by lower income from divested businesses in 2017 compared to the prior year due to gains on the sales of United Guaranty, AIG Advisor Group and NSM, partially offset by losses on the agreements to sell Fuji Life to FWD Group and certain insurance operations and assets to Fairfax.
Personal Insurance focuses on individual customers, as well as group and corporate clients. Although market competition within Personal Insurance has increased, we continue to benefit from the underwriting quality, portfolio diversity, and low volatility of the short-tailed risk in the business. We expect our newly formed entity in Japan - AIG Sonpo - to provide the necessary scale and platform to compete more efficiently in the Japanese market. Outside of Japan, Personal Insurance continues to invest selectively in international markets, which we believe have higher potential for sustainable profitability.
(a) Geography: North America primarily includes insurance businesses in the United States, Canada and Bermuda. International includes insurance businesses in Japan, the United Kingdom, Europe, the Asia Pacific region, Latin America, Puerto Rico, Australia, the Middle East and Africa. Geography results are presented before consideration of internal reinsurance agreements.
• higher current accident year loss ratio, as adjusted, in Casualty and programs business, partially offset by lower severe losses;
• lower net investment income reflecting lower income on alternative investments and lower interest and dividends on invested assets.
• higher net investment income reflecting higher commercial mortgage loan prepayments, growth in average invested assets and higher gains on securities for which the fair value option was elected, partially offset by lower income on alternative investments;
• better equity market performance contributed to decreases in policyholder benefit expense and DAC amortization. Excluding the impact of actuarial assumption updates and equity market performance, DAC amortization increased primarily due to higher rate of amortization in Fixed Annuities and growth in Index Annuities;
• higher policy fees due to growth in annuity account values from positive net flows; and
• higher policyholder benefits primarily due to increases in reserves for guaranteed benefits;
Adjusted pre-tax loss increased primarily due to higher Parent and Other corporate general operating expenses partially offset by lower interest expense. Parent and Other general operating expenses increased in 2016 due to higher technology costs as a result of our investment in our infrastructure, offset by lower professional fees and employee related costs, consistent with our strategy to reduce expenses. In addition, 2015 included a $175 million pension curtailment credit. Parent and Other interest expense decreased primarily as a result of liability management activities.
• lower Legacy Life and Retirement earnings in 2016 compared to 2015 primarily due to lower net investment income on investments and higher loss recognition on certain payout annuities from the update of actuarial assumptions;
In periods subsequent to the recognition of an other-than-temporary impairment charge for available for sale fixed maturity securities that is not foreign-exchange related, we generally prospectively accrete into earnings the difference between the new amortized cost and the expected undiscounted recoverable value over the remaining life of the security. The accretion that was recognized for these securities in earnings was $669 million in 2017, $767 million in 2016 and $735 million in 2015.
(d) The effect on Net income of unrealized losses after taxes will be mitigated upon realization because certain realized losses will result in current decreases in the amortization of certain DAC.
The following table presents the rollforward of activity in the deferred gain from the adverse development reinsurance agreement:
In Variable and Index Annuities, the update of estimated gross profit assumptions resulted in a net positive adjustment of $112 million in 2017, primarily due to an increase in the reversion to the mean rate used for projecting future estimated gross profit for variable annuity products and changes in volatility assumptions. The net positive adjustment was partially offset by a decrease in the separate account long-term asset growth rate assumption from 7.5 percent to 7.0 percent (before expenses that reduce the asset base from which future fees are projected) and a negative adjustment in connection with the conversion to a new modeling platform for Index Annuities.
• approximately $10.7 billion to repurchase approximately 182 million shares of AIG Common Stock; and
During 2016, we created a new Switzerland-domiciled international holding company, AIG International Holdings, GmbH (AIGIH), which is intended to be the ultimate holding company for all of our international entities. This international holding company structure is part of our ongoing efforts to simplify our organizational structure, and is expected to facilitate the optimization of our international capital strategy from both a regulatory and tax perspective. Through February 8, 2018, substantially all of our international operations have been transferred to AIGIH. We will continue to monitor our international holding company structure in light of regulatory, tax and other developments, to ensure that this strategy continues to be effective.
As of December 31, 2017, a total of $4.5 billion remains available under the Facility. Our ability to utilize the Facility is not contingent on our credit ratings. However, our ability to utilize the Facility is conditioned on the satisfaction of certain legal, operating, administrative and financial covenants and other requirements contained in the Facility. These include covenants relating to our maintenance of a specified total consolidated net worth and total consolidated debt to total consolidated capitalization. Failure to satisfy these and other requirements contained in the Facility would restrict our access to the Facility and could have a material adverse effect on our financial condition, results of operations and liquidity. We expect to utilize the Facility from time to time, and may use the proceeds for general corporate purposes.
Loss reserves relate to our General Insurance companies and represent estimates of future loss and loss adjustment expense payments estimated based on historical loss development payment patterns. Due to the significance of the assumptions used, the payments by period presented above could be materially different from actual required payments. We believe that our General Insurance companies maintain adequate financial resources to meet the actual required payments under these obligations.
The Group Risk Committee (GRC): The GRC is the senior management group responsible for assessing all significant risk issues on a global basis to protect our financial strength, optimize our intrinsic value, and protect our reputation. The GRC is chaired by our CRO. Its membership includes our CEO, Chief Financial Officer (CFO), and other senior executives from across our corporate functions and business units. Our CRO reports periodically on behalf of the GRC to both the RCC and the Audit Committee of the Board of Directors. Our CRO is also a member of the Executive Leadership Team (ELT) providing ERM the opportunity to contribute to, review, monitor and consider the impact of changes in strategy.
For further discussion of reinsurance recoverable see Critical Accounting Estimates - Reinsurance Assets
Noncontrolling interest The portion of equity ownership in a consolidated subsidiary not attributable to the controlling parent company.
Common and preferred stock available for sale, at fair value (cost: 2017 - $1,305; 2016 - $1,697)
Other assets, including restricted cash of $317 in 2017 and $193 in 2016
Other liabilities (portion measured at fair value: 2017 - $1,124; 2016 - $2,016)
• income tax assets and liabilities, including recoverability of our net deferred tax asset and the predictability of future tax operating profitability of the character necessary to realize the net deferred tax asset and provisional estimates associated with the Tax Act.
The following table identifies our significant accounting policies presented in other Notes to these Consolidated Financial Statements, with a reference to the Note where a detailed description can be found:
We will adopt this standard on its effective date of January 1, 2018 under the modified retrospective approach. Based on our evaluation, 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.
· Blackboard - a data-enabled, digital subsidiary that provides the commercial insurance industry with alternative solutions using digital technology, data analytics and automation
The following tables present changes during the years ended December 31, 2017 and 2016 in Level 3 assets and liabilities measured at fair value on a recurring basis, and the realized and unrealized gains (losses) related to the Level 3 assets and liabilities in the Consolidated Balance Sheets at December 31, 2017 and 2016:
Both observable and unobservable inputs may be used to determine the fair values of positions classified in Level 3 in the tables above. As a result, the unrealized gains (losses) on instruments held at December 31, 2017 and 2016 may include changes in fair value that were attributable to both observable (e.g., changes in market interest rates) and unobservable inputs (e.g., changes in unobservable long-dated volatilities).
During the years ended December 31, 2017 and 2016, transfers into Level 3 assets primarily included certain investments in private placement corporate debt, RMBS, CMBS and CDO/ABS. Transfers of private placement corporate debt and certain ABS into Level 3 assets were primarily the result of limited market pricing information that required us to determine fair value for these securities based on inputs that are adjusted to better reflect our own assumptions regarding the characteristics of a specific security or associated market liquidity. The transfers of investments in RMBS, CMBS and CDO and certain ABS into Level 3 assets were due to decreases in market transparency and liquidity for individual security types.
Shadow DAC and Shadow Loss Recognition: DAC related to investment-oriented products is also adjusted to reflect the effect of unrealized gains or losses on fixed maturity and equity securities available for sale on estimated gross profits, with related changes recognized through Other comprehensive income (shadow DAC). The adjustment is made at each balance sheet date, as if the securities had been sold at their stated aggregate fair value and the proceeds reinvested at current yields. Similarly, for long-duration traditional insurance contracts, if the assets supporting the liabilities are in a net unrealized gain position at the balance sheet date, loss recognition testing assumptions are updated to exclude such gains from future cash flows by reflecting the impact of reinvestment rates on future yields. If a future loss is anticipated under this basis, any additional shortfall indicated by loss recognition tests is recognized as a reduction in accumulated other comprehensive income (shadow loss recognition). Similar to other loss recognition on long-duration insurance contracts, such shortfall is first reflected as a reduction in DAC and secondly as an increase in liabilities for future policy benefits. The change in these adjustments, net of tax, is included with the change in net unrealized appreciation of investments that is credited or charged directly to Other comprehensive income.
We created certain VIEs that hold investments, primarily in investment-grade debt securities and loans, and issued beneficial interests in these investments. The majority of these beneficial interests are owned by our insurance operations and we maintain the power to direct the activities of the VIEs that most significantly impact their economic performance and bear the obligation to absorb losses or receive benefits from the entities that could potentially be significant to the entities. Accordingly, we consolidate these entities and those beneficial interests issued to third-parties are reported as Long-term debt. Total assets of consolidated securitization vehicles are $18.1 billion, of which $17.6 billion represents amounts owed to Parent or its subsidiaries.
We estimate that at December 31, 2017, based on our outstanding financial derivative transactions, a downgrade of our long-term senior debt ratings to BBB or BBB- by Standard & Poor’s Financial Services LLC, a subsidiary of S&P Global Inc., and/or a downgrade to Baa2 or Baa3 by Moody’s Investors’ Service, Inc. would permit counterparties to make additional collateral calls and permit certain counterparties to elect early termination of contracts, resulting in corresponding collateral postings and termination payments in the total amount of up to approximately $83 million. The aggregate fair value of our derivatives that were in a net liability position and that contain such credit risk-related contingencies which can be triggered below our long-term senior debt ratings of BBB+ or Baa1 was approximately $572 million and $848 million at December 31, 2017 and 2016, respectively. The aggregate fair value of assets posted as collateral under these contracts at December 31, 2017 and 2016, was approximately $676 million and $875 million, respectively.
Goodwill was not impaired at December 31, 2017 based on the results of the goodwill impairment test.
• Unfavorable development in U.S. Financial Lines, primarily from Directors & Officers (D&O) policies covering privately owned and not-for-profit insureds. This development was predominantly in accident year 2016 and resulted largely from increases in bankruptcy-related claims and fiduciary liability claims for large educational institutions.
During 2016, we recognized $1.1 billion of unfavorable prior year development in Excess Casualty driven by continued higher than expected loss emergence.
In 2016, we recognized $1.6 billion of unfavorable prior year development in Other Casualty as a result of increased frequency and severity in all three product lines.
In 2015, we also reassessed the reasonableness of our primary general liability and commercial auto liability for future claim handling expenses related to existing loss reserves and updated our estimates to reflect the costs from recent investments in claims systems, processes and people with the objective of improving our ability to better manage total loss costs. We increased our reserve estimates by $214 million based on refined analyses, $100 million of which was attributable to U.S. general liability. The balance was distributed among other product lines.
During 2015, we recognized $4 million of unfavorable prior year development from a number of large individual property claims.
During 2017, we recognized $58 million of favorable prior year development in Europe and Japan Personal Insurance mainly due to accident and health business.
The following table presents the other comprehensive income (loss) reclassification adjustments for the years ended December 31, 2017, 2016 and 2015:
The 2010 Plan was adopted at the 2010 Annual Meeting of Shareholders. The total number of shares of AIG Common Stock that could be granted under the 2010 Plan was 60 million. During 2013, we granted PSUs, DSUs and RSUs under the 2010 Plan. Each PSU, DSU and RSU awarded reduced the number of shares available for future grants by one share. Subsequent to the adoption of the Omnibus Plan in May 2013, no additional grants were made under the 2010 Plan.
The number of PSUs issued on the grant date (the target) provides the opportunity for the LTIP participant to receive shares of AIG Common Stock based on AIG achieving specified performance goals at the end of a three-year performance period. These performance goals are pre-established by AIG’s Compensation and Management Resources Committee (CMRC) for each annual grant and may differ from year to year. The actual number of PSUs earned can vary from zero to 200 percent of the target for the 2017 awards, or zero to 150 percent of the target for the 2013 through 2016 awards, depending on AIG’s performance relative to a specified peer group. RSUs are earned based on continued service by the participant. For the 2017 awards, vesting occurs on January 1 of the year immediately following the end of the three-year performance period. For awards granted prior to 2017, vesting occurs in three equal installments beginning on January 1 of the year immediately following the end of a performance period and January 1 of each of the next two years. Recipients must be employed at each vesting date to be entitled to share delivery, except upon the occurrence of an accelerated vesting event, such as an involuntary termination without cause, disability, retirement eligibility or death during the vesting period.
A Schedule 13G/A filed on February 12, 2018 reports aggregate ownership of 61,323,039 shares, or approximately 6.8 percent (based on the AIG Common Stock outstanding) of AIG Common Stock as of December 31, 2017, by The Vanguard Group, Inc. and various subsidiaries thereof.
The Tax Act modified computations of insurance reserves for both life and general insurance companies. For life insurance companies, tax reserves are now computed with reference to NAIC reserves. For general insurance companies, the Tax Act extends the discount period for certain long-tail lines of business from 10 years to 24 years and increases the discount rate, replacing the applicable federal rate for a higher-yield corporate bond rate, and eliminates the election allowing companies to use their historical loss payment patterns for loss reserve discounting. Adjustments related to the differences in insurance reserves balances computed under the old tax law versus the Tax Act have to be taken into income over eight years by both life and general insurance companies. Accordingly, at December 31, 2017, these changes give rise to new deferred tax liabilities. We have recorded a provisional estimate of $1.9 billion with respect to such deferred tax liabilities. This increase in deferred tax liabilities is offset by an increase in the deferred tax asset related to insurance reserves as a result of applying the new provisions of the Tax Act.