Accident year combined ratio, as adjusted: the combined ratio excluding catastrophe losses and related reinstatement premiums, prior year development, net of premium adjustments, and the impact of reserve discounting.
Mortgage Guaranty reported new insurance written of $37.5 billion for 2012 compared to $18.8 billion in 2011 and has experienced improving credit trends.
We completed $13.0 billion in share purchases using a portion of the proceeds of our asset sales.
We manage risks better by applying performance metrics that enable us to assess risk more clearly and address evolving market conditions.
Reduce recurring operating expenses by leveraging AIG's scale and driving increased standardization through investments in infrastructure.
AIG Markets acts as the derivatives intermediary between AIG and its subsidiaries and third parties to provide hedging services. The derivative portfolio of AIG Markets consists primarily of interest rate and currency derivatives.
pre-tax income from insurance operations of $5.6 billion in 2012, which included catastrophe losses of $2.7 billion, largely arising from Storm Sandy, and severe losses of $326 million, compared to pre-tax income from insurance operations of $4.8 billion in 2011, which included catastrophe losses of $3.3 billion, largely arising from Hurricane Irene, U.S. tornadoes and the Great Tohoku Earthquake & Tsunami in Japan (the Tohoku Catastrophe) and severe losses of $296 million;
After-tax operating income increased in 2012 compared to 2011 primarily due to increases in income from insurance operations and in the fair value gains on AIG's interest in AIA ordinary shares and AIG's interest in ML III, discussed above. This was partially offset by an increase in income tax expenses in 2012 compared to an income tax benefit in 2011.
For the year ended December 31, 2012, the effective tax rate on pre-tax operating income was 31.6 percent. The effective tax rate for the year ended December 31, 2012, attributable to pre-tax operating income differs from the statutory rate primarily due to tax exempt interest income and other permanent tax items.
Operating income increased in 2011, reflecting the effect of rate increases and enhanced risk selection. These items were partially offset by higher catastrophe losses, higher acquisition expenses and a decrease in the allocated net investment income due to a decrease in the risk-free rate. In 2011, catastrophe losses, adjusted for reinstatement premiums, were $2.6 billion compared to $1.0 billion in 2010, as 2011 included the impact of the Tohoku Catastrophe in Japan and the earthquakes in New Zealand. In 2011, net prior year favorable development, including premium adjustments, was $455 million compared to net prior year adverse development of $2.6 billion in 2010.
Specialty net premiums written increased in 2012 due to the restructuring of the aerospace reinsurance program to retain more favorable risks while continuing to manage aggregate exposure. This increase was slightly offset by our strategic initiatives related to improved risk selection, particularly within products provided to small and medium sized enterprises in the Americas and EMEA regions. We continue to shift our business mix towards higher value lines, particularly in aerospace.
Consumer Insurance net premiums written increased in 2011 primarily due to the effect of including Fuji results for a full year, improvement in foreign currency exchange rates, primarily in the Japanese Yen, and further growth in the strategic higher value lines of business. Excluding the effect of the Fuji acquisition and foreign exchange, Consumer Insurance net premiums written declined by one percent in 2011, primarily due to the non-renewal of certain programs in the U.S. and Canada that did not meet internal performance targets in Personal lines business.
In addition to the U.S. asbestos and environmental reserve amounts shown in the tables below, AIG Property Casualty also has asbestos reserves relating to foreign risks written by non-U.S. entities of $140 million gross and $116 million net as of December 31, 2012. The asbestos reserves relating to non-U.S. risks written by non-U.S. entities were $233 million gross and $165 million net as of December 31, 2011.
The following table presents AIG's survival ratios for asbestos and environmental claims at December 31, 2012, 2011 and 2010. The survival ratio is derived by dividing the current carried loss reserve by the average payments for the three most recent calendar years for these claims. Therefore, the survival ratio is a simplistic measure estimating the number of years it would take before the current ending loss reserves for these claims would be paid off using recent year average payments.
Premiums decreased slightly in 2012 due to lower group benefit premiums partially offset by higher term insurance premiums.
Policyholder benefits and claims incurred increased in 2012 reflecting higher mortality costs and loss recognition reserves, partially offset by lower charges to increase reserves for death claims as described below:
Other acquisition and insurance expenses increased in 2012 due to higher marketing and distribution expenses associated with growth initiatives for variable annuities and group retirement products.
Other income increased due to the previously discussed legal settlement proceeds of $226 million in 2011 to resolve a litigation matter as discussed above.
The following tables summarize AIG Life and Retirement premiums, deposits and other considerations by product*:
The following table presents reserves by surrender charge category and surrender rates:
Mortgage Guaranty recorded an operating loss in 2011 compared to operating income in 2010, primarily due to:
The loss attributable to AIG's interest in ML III for 2011 was due to significant spread widening and reduced interest rates.
•total payments of approximately $13.0 billion for the purchase of approximately 421 million shares of AIG Common Stock. Net cash used in financing activities for 2011 primarily resulted from the repayment of the FRBNY Credit Facility and the $12.4 billion partial repayment of the AIA SPV Preferred Interests and the ALICO SPV in connection with the Recapitalization and use of proceeds received from the sales of foreign life insurance entities in 2011.
received non-cash dividends of approximately $1.0 billion in the form of municipal bonds from AIG Property Casualty;
issued $750 million principal amount of 3.000% Notes Due 2015 and $1.25 billion principal amount of 3.800% Notes Due 2017. These proceeds were used to continue to reduce the risk of, and better match the assets and liabilities in, the MIP (described more fully in Other Operations - Direct Investment Book below);
issued $250 million principal amount of 2.375% Subordinated Notes Due 2015. Proceeds from this offering are being used for general corporate purposes; and
paid $550 million as a result of final approval of a settlement under the Consolidated 2004 Securities Litigation (see Note 16 to the Consolidated Financial Statements for additional information); and
•other potential events that could cause a liquidity strain, including economic collapse of a nation or region significant to our operations, nationalization, catastrophic terrorist acts, pandemics or other events causing economic or political upheaval. In February 2012, AIG Parent, Chartis Inc. and certain AIG Property Casualty domestic insurance subsidiaries, entered into a single CMA, which replaced the CMAs entered into in February 2011. Under the 2012 CMA, the total adjusted capital and total authorized control level Risk-Based Capital (RBC) (as defined by National Association of Insurance Commissioners (NAIC) guidelines and determined based on the subsidiaries' statutory financial statements) of these AIG Property Casualty insurance subsidiaries are measured as a group (the Fleet) rather than on an individual company basis.
In addition, the CMAs provide that if the total adjusted capital of these AIG Life and Retirement insurance subsidiaries is in excess of that same specified minimum percentage of their respective total company action level RBC, subject to board approval, the subsidiaries would declare and pay ordinary dividends to their respective equity holders up to an amount that is the lesser of:
•The DIB used current program liquidity to pay down $6.6 billion in debt. In addition, in the first quarter of 2012, AIG issued $2.0 billion aggregate principal amount of unsecured notes, consisting of $750 million principal amount of 3.000% Notes Due 2015 and $1.25 billion principal amount of 3.800% Notes Due 2017. The proceeds from the sale of these notes were used to reduce overall risk and better match the assets and liabilities in the MIP. The notes are included within MIP notes payable in the debt outstanding table in "Debt - Debt Maturities" below.
We maintain a committed revolving four-year syndicated credit facility (the Four-Year Facility) as a potential source of liquidity for general corporate purposes. The Four-Year Facility also provides for the issuance of letters of credit. We currently expect to replace or extend the Four-Year Facility on or prior to its expiration in October 2016, although no assurance can be given that the Four-Year Facility will be replaced on favorable terms or at all.
For a discussion of the effects of downgrades in the financial strength ratings of our insurance companies or our credit ratings, see Note 12 to the Consolidated Financial Statements and Part I, Item 1A. Risk Factors.
Our investment strategies are tailored to the specific business needs of each operating unit. The investment objectives are driven by the business model for each of the businesses: AIG Property Casualty, AIG Life and Retirement, and the Direct Investment book. The primary objectives are generation of investment income, preservation of capital, liquidity management and growth of surplus to support the insurance products. The majority of assets backing our insurance liabilities consist of intermediate and long duration fixed maturity securities.
(a) At December 31, 2012, approximately 88 percent and 12 percent of investments were held by domestic and foreign entities, respectively, compared to approximately 90 percent and 10 percent, respectively, at December 31, 2011.
Credit risk is defined as the risk that our customers or counterparties are unable or unwilling to repay their contractual obligations when they become due. Credit risk may also result from a downgrade of counterparty's credit ratings.
•The remaining credit exposures to this sector were primarily related to reinsurance recoverables, collateral extended to counterparties mostly pursuant to derivative transactions, derivatives, and captive fronting risk management programs for these financial institutions.
(b) Calculated using the AIG reinsurance program in effect as at January 1, 2013, including reinstatement premiums. AIG's reinsurance program includes industry loss warranty (ILW) contracts under which there is basis risk between AIG's losses and the total industry loss. The net of reinsurance amount in the table above includes a positive impact from these ILWs, which may not be indicative of actual experience.
Interest rate risk - represents the exposure to loss due to the sensitivity of the liabilities and assets to changes in interest rates; and
For United Guaranty Corporation (UGC), risks emanate primarily from the following:
impairment charges, including other-than-temporary impairments of financial instruments and goodwill impairments;
We record quarterly changes in loss reserves for each of AIG Property Casualty's classes of business. The overall change in our loss reserves is based on the sum of the changes for all classes of business. For most long-tail classes of business, the quarterly loss reserve changes are based on the estimated current loss ratio for each class of coverage less any amounts paid. Also, any change in estimated ultimate losses from prior accident years deemed to be necessary based on the results of our latest reserve studies or large loss analysis, either positive or negative, is reflected in the loss reserve for the current quarter.
territorial experience differences (across states and within regions in a state).
The assumed loss cost trend was approximately half of one percent. After evaluating the historical loss cost trends from prior accident years since the early 1990s, including the potential effect of recent claims relating to the credit crisis, in our judgment, it is reasonably likely that actual loss cost trends applicable to the year-end 2012 loss reserve review for these classes will range from negative 25 percent to positive 27 percent, or approximately 25.5 percent lower or 26.5 percent higher than the assumption actually utilized in the year-end 2012 reserve review. Because the D&O class of business has exhibited highly volatile loss trends from one accident year to the next, there is the possibility of an exceptionally high deviation.
(b) Percentages not applicable due to extremely long-tailed nature of workers' compensation.
Mortality, morbidity and surrender rates: based upon actual experience modified to allow for variation in policy form, risk classification and distribution channel.
We also issue certain variable annuity products that offer optional guaranteed minimum withdrawal benefits (GMWB) and guaranteed minimum account value benefits (GMAV). These living benefits are embedded derivatives that are required to be bifurcated from the host contract and carried at fair value. The fair value estimates of the living benefit guarantees include assumptions such as equity market returns, interest rates, market volatility and policyholder behavior. We also incorporate our own risk of non-performance in the valuation of the embedded policy derivatives. See Note 6 to the Consolidated Financial Statements for information on how AIG incorporates its own non-performance risk.
See Note 6 to the Consolidated Financial Statements for more detailed information about the measurement of fair value of financial assets and financial liabilities and how our accounting policy incorporates credit risk in fair value measurements.
See Notes 6 and 12 to the Consolidated Financial Statements for information about the Regulatory Capital, Multi-Sector CDO, Corporate Debt/Collateralized Debt Obligation (CLO) and other portfolios.
The most significant assumption used in the BET model is the estimated price of the securities within the CDO collateral pools. If the actual price of the securities within the collateral pools differs from the price used in estimating the fair value of the super senior credit default swap portfolio, there is potential for material variation in the fair value estimate. Any declines in the value of the underlying collateral securities held by a CDO will similarly affect the value of the super senior CDO securities. While the models attempt to predict changes in the prices of underlying collateral securities held within a CDO, the changes are subject to actual market conditions which have proved to be highly volatile. We cannot predict reasonably likely changes in the prices of the underlying collateral securities held within a CDO at this time.
AIG Life and Retirement - Premiums, deposits and other considerations includes life insurance premiums and deposits on annuity contracts and mutual funds.
Reserve deficiency When actual reported reserves are lower than the expected reserves. This is also referred to as unfavorable loss development.
Severe losses Individual non-catastrophe first party losses greater than $10 million, net of related reinsurance.
(m) Future policy benefits for life and accident and health insurance contracts and policyholder contract deposits: For discussion of our accounting policies on future policy benefits and life and accident and health insurance contracts and policyholder contract deposits, see Note 13 herein. See Note 6 herein for additional fair value information.
The standard is effective for fiscal years and interim periods beginning on or after January 1, 2013, and will be applied retrospectively to all comparative periods presented. We do not expect adoption of the standard to have a material effect on our consolidated financial condition, results of operations or cash flows.
The standard is effective for annual and interim reporting periods beginning after December 15, 2012. We do not expect adoption of the standard to have a material effect on our consolidated financial condition, results of operations or cash flows.
(d) Includes an adjustment to the after-tax gain on the sale of ALICO of $1.6 billion in the fourth quarter of 2010.
Adoption of the standard did not affect the previously reported totals for net cash flows provided by (used in) operating, investing, or financing activities, but did affect the following components of net cash flows provided by (used in) operating activities.
Level 3 valuation inputs. The new disclosure requirements were applied prospectively. The standard became effective beginning on January 1, 2012. The standard did not have any effect on our consolidated financial condition, results of operations or cash flows. See Note 6 for additional information related to fair value measurements.
On March 7, 2010, AIG and the special purpose vehicle holding the proceeds of the sale of ALICO (ALICO SPV) entered into a definitive agreement with MetLife for the sale of ALICO by the ALICO SPV to MetLife, and the sale of Delaware American Life Insurance Company by AIG to MetLife, for consideration then valued at approximately $15.5 billion, consisting of $6.8 billion in cash and the remainder in equity securities of MetLife, subject to closing adjustments. The ALICO sale closed on November 1, 2010. We do not have any significant continuing involvement with or significant continuing cash flows from ALICO. The fair value of the consideration at closing was approximately $16.2 billion. At December 31, 2010, a total of $6.5 billion was included in common and preferred stock trading.
For certain OTC derivatives that trade in less liquid markets, where we generally do not have corroborating market evidence to support significant model inputs and cannot verify the model to market transactions, the transaction price may provide the best estimate of fair value. Accordingly, when a pricing model is used to value such an instrument, the model is adjusted so the model value at inception equals the transaction price. We will update valuation inputs in these models only when corroborated by evidence such as similar market transactions, third party pricing services and/or broker or dealer quotations, or other empirical market data. When appropriate, valuations are adjusted for various factors such as liquidity, bid/offer spreads and credit considerations. Such adjustments are generally based on available market evidence. In the absence of such evidence, management's best estimate is used.
(c) Level 1 Other invested assets included $12.4 billion at December 31, 2011 of AIA ordinary shares publicly traded on the Hong Kong Stock Exchange.
During 2012, 2011 and 2010, we recognized losses of $641 million, gains of $420 million and losses of $779 million, respectively, attributable to the observable effect of changes in credit spreads on our own liabilities for which the fair value option was elected. We calculate the effect of these credit spread changes using discounted cash flow techniques that incorporate current market interest rates, our observable credit spreads on these liabilities and other factors that mitigate the risk of nonperformance such as cash collateral posted.
* Excludes Long-term debt of ILFC reclassed to Liabilities held for sale on the Consolidated Balance Sheet.
For the year ended December 31, 2012, 2011 and 2010, the aggregate fair value of available for sale securities sold was $40.3 billion, $44.0 billion and $56.0 billion, which resulted in net realized capital gains of $3.1 billion, $2.1 billion and $2.6 billion, respectively.
Life settlement contracts are accounted for under the investment method. Under the investment method, we recognize our initial investment in life settlement contracts at the transaction price plus all initial direct external costs. Continuing costs to keep the policy in force, primarily life insurance premiums, increase the carrying value of the investment. We recognize income on individual life settlement contracts when the insured dies, at an amount equal to the excess of the contract proceeds over the carrying amount of the contract at that time. Contracts are reviewed for indications that the expected future proceeds from the contract would not be sufficient to recover our estimated future carrying amount of the contract, which is the current carrying amount for the contract plus anticipated undiscounted future premiums and other capitalizable future costs. Any such contracts identified are written down to their estimated fair value.
•the security has traded at a significant (25 percent or more) discount to cost for an extended period of time (nine consecutive months or longer);
(a) The assets of each VIE can be used only to settle specific obligations of that VIE.
(c) Notional amount of derivative liabilities and fair values of derivative liabilities include $23 billion and $1.3 billion, respectively, at December 31, 2012 and $18.3 billion and $0.9 billion, respectively at December 31, 2011 related to bifurcated embedded derivatives. A bifurcated embedded derivative is generally presented with the host contract in the Consolidated Balance Sheet.
•Participating life business represented approximately 2.0 percent of the gross insurance in force at December 31, 2012 and 4.2 percent of gross Premiums and other considerations in 2012. The amount of annual dividends to be paid is approved locally by the boards of directors of the life 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.
(b) Represents the amount of death benefit currently in excess of Account value.
Finally, the AIG defendants have settled the four state court actions filed in Florida, New Jersey, Texas, and Kansas state courts, where plaintiffs had made similar allegations as those asserted in the Multi-District Litigation.
The following table presents the future minimum lease payments under operating leases:
In connection with the indemnity obligations described above, as of December 31, 2012, approximately $567 million of proceeds from the sale of ALICO were on deposit in an escrow arrangement. Under the terms of a letter agreement between MetLife and us entered into on April 26, 2012, $44 million was released to us on April 30, 2012 which represented funds that were initially held back from the release of escrow to us on November 1, 2011. Under the terms of a letter agreement between MetLife and us entered into on July 13, 2012, $950 million was released to us on August 31, 2012 instead of November 1, 2012 as originally provided under the ALICO stock purchase agreement. An additional $33 million was released on November 8, 2012. The amount required to be held in escrow declines to zero in May 2013, although indemnification claims then pending will reduce the amount that can be released to us.
On November 23, 2010, we commenced an offer to exchange up to 74,480,000 of our Equity Units for consideration per Equity Unit equal to 0.09867 share of AIG Common Stock plus $3.2702 in cash (the Exchange Offer). The stock and cash received was the result of netting payments from two separate transactions, a repurchase of the subordinated debentures and a cancellation of the stock purchase contracts.
The expected long-term rate of return for the plan was 7.25 and 7.50 percent for 2012 and 2011, respectively. The expected rate of return is an aggregation of expected returns within each asset class category and incorporates the current and target asset allocations. The combination of the expected asset return and any contributions made by us are expected to maintain the plans' 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 changes in our U.S. and Non-U.S. Level 3 plan assets measured at fair value:
Our policy is to record transfers of assets and liabilities between Level 1 and Level 2 at their fair values as of the end of each reporting period, consistent with the date of the determination of fair value. Assets are transferred out of Level 1 when they are no longer transacted with sufficient frequency and volume in an active market. Conversely, assets are transferred from Level 2 to Level 1 when transaction volume and frequency are indicative of an active market. We had no significant transfers between Level 1 and Level 2 during the year ended December 31, 2012.
Funding for the U.S. pension plan ranges from the minimum amount required by ERISA to the maximum amount that would be deductible for U.S. tax purposes. Contributed amounts in excess of the minimum amounts are deemed voluntary. Amounts in excess of the maximum amount would be subject to an excise tax and may not be deductible under the Internal Revenue Code. There are no minimum required cash contributions for the AIG Retirement Plan in 2013. Supplemental, AIG NQRIP and postretirement plan payments are deductible when paid.
We regularly evaluate adjustments proposed by taxing authorities. At December 31, 2012, such proposed adjustments would not have resulted in a material change to our consolidated financial condition, although it is possible that the effect could be material to our consolidated results of operations for an individual reporting period. Although it is reasonably possible that a change in the balance of unrecognized tax benefits may occur within the next 12 months, based on the information currently available, we do not expect any change to be material to our consolidated financial condition.