• Part I, Item 1A. Risk Factors of this Annual Report on Form 10-K; and
We are continuing to invest in initiatives to enable simpler and more agile low-cost operating models to provide superior service and position our operating platforms to accommodate significant future growth. In Japan, we continue to invest in technology and systems to improve operating efficiency and make it easier for our partners and our customers to do business with us, with the intent to ultimately increase our market share and facilitate our expansion in segments of the market that are expected to grow over the next decade, given demographic trends. In the U.S. Life business, we are focused on leveraging our most efficient systems environments and increased automation of our underwriting process. We believe that these simpler operating models will allow for productivity improvements and enhance our ability to leverage common functionality across product lines and borders, further supporting profitable growth.
Property net premiums written increased in 2014 compared to 2013 primarily due to new business increases in targeted growth products, and optimization of Property Casualty’s reinsurance structure as part of its decision to retain more favorable risks while continuing to manage aggregate exposure.
The combined ratio decreased by 1.4 points in 2014 compared to 2013 reflecting decreases in the expense ratio and the loss ratio.
The accident year loss ratio, as adjusted, increased by 0.2 points in 2014, compared to 2013, primarily due to higher frequency of non-severe losses, particularly in Property and Specialty businesses. This was partially offset by an improvement in Financial lines, particularly in the U.S., reflecting enhanced risk selection and pricing discipline. Severe losses represented approximately 2.8 points of the accident year loss ratio, as adjusted, in both 2014 and 2013.
Pre-tax operating income increased in 2014 compared to 2013 due to a decline in incurred losses from lower delinquency rates, higher cure rates and an increase in first-lien net premiums earned reflecting higher persistency.
Renewal crediting rate management is done under contractual provisions in annuity products that were designed to allow crediting rates to be reset at pre-established intervals subject to minimum crediting rate guarantees. Retirement has adjusted, and will continue to adjust, crediting rates to maintain targeted net investment spreads on in-force business. In addition to deferred annuity products, certain traditional long-duration products for which Retirement does 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. See Insurance Reserves - Life Insurance Companies DAC and Reserves - Loss Recognition for additional discussion.
Premiums and deposits decreased in 2014 compared to 2013, due to the decrease in premiums, and were consistent in 2013 with 2012.
The accident year loss ratio, as adjusted, decreased by 3.6 points in 2014 compared to 2013, as a result of improvements across all lines of business. The lower losses associated with a warranty retail program were largely offset by an increase in the related profit sharing arrangement, which increased the acquisition ratio in 2014 compared to 2013. The severe losses of $54 million, resulting largely from four fire claims, accounted for 0.5 points of the accident year loss ratio, as adjusted, in 2014.
The accident year combined ratio, as adjusted, increased by 2.8 points in 2013 compared to 2012.
due to equity market performance and lower reinvestment yields on our fixed maturity securities portfolio due to the low interest rate environment.
In addition, the Non-Life Insurance Companies seek to enhance returns through investments in a diversified portfolio of private equity funds and hedge funds. Although these alternative investments are subject to periodic earnings fluctuations, they have historically achieved yields in excess of the fixed maturity portfolio yields and have provided added diversification to the broader portfolio. The Non-Life Insurance Companies’ investment portfolio also includes, to a lesser extent, equity securities and other yield-enhancing investments.
The Life Insurance Companies invest primarily in fixed maturity securities issued by corporations, municipalities and other governmental agencies; structured securities collateralized by, among other assets, residential and commercial real estate; and commercial mortgage loans.
* At both December 31, 2014 and December 31, 2013, approximately 93 percent of these investments were rated investment grade.
* Includes approximately $13.5 billion and $11.3 billion at December 31, 2014 and 2013, respectively, of certain RMBS that had experienced deterioration in credit quality since their origination. See Note 6, Investments - Purchase Credit Impaired (PCI) Securities to the Consolidated Financial Statements for additional discussion.
Gross loss reserves represent the accumulation of estimates of ultimate losses, including estimates for IBNR and loss expenses, less estimated salvage and subrogation and applicable discount. The Non-Life Insurance Companies regularly review and update the methods and assumptions used to determine loss reserve estimates and to establish the resulting reserves. Any adjustments resulting from this review are reflected in pre-tax operating income. Because loss reserve estimates are subject to the outcome of future events, changes in estimates are unavoidable given that loss trends vary and time is often required for changes in trends to be recognized and confirmed. Reserve changes that increase prior years’ estimates of ultimate cost are referred to as unfavorable or adverse development or reserve strengthening. Reserve changes that decrease prior years’ estimates of ultimate cost are referred to as favorable development. See MD&A Critical Accounting Estimates - Details of the Loss Reserving Process.
Pre-tax operating income in 2014, 2013 and 2012 reflected the net effect of adjustments to update actuarial assumptions for the domestic Life Insurance Companies. These adjustments included unlocking of estimated gross profit assumptions for investment-oriented products as well as loss recognition expense to increase reserves for certain traditional blocks of business. See Critical Accounting Estimates - Estimated Gross Profits for Investment-Oriented Products, Critical Accounting Estimates - Future Policy Benefits for Life and Accident and Health Insurance Contracts, Unlocking of Estimated Gross Profits below, and Loss Recognition below, for additional discussion of the process and results related to assumption changes.
The Life Insurance Companies review and update estimated gross profit assumptions used to amortize DAC and related items for investment-oriented products at least annually. The increases (decreases) to pre-tax operating income and pre-tax income of these assumption updates by product line and financial statement line item, respectively, are shown in the following tables. These adjustments do not include loss recognition on certain long-term care products; see Loss Recognition below for additional discussion of the update of assumptions for certain long-term care products.
In 2012, pre-tax operating income of the Life Insurance Companies in aggregate increased by a net positive adjustment of $41 million as a result of the update of estimated gross profit assumptions. The net positive adjustment in 2012 was primarily due to improved surrender assumptions for fixed annuities, partially offset by lower yield and spread assumptions for universal life and for certain blocks of fixed annuities.
Capital refers to the long-term financial resources available to support the operation of our businesses, fund business growth, and cover financial and operational needs that arise from adverse circumstances. Our primary source of ongoing capital generation is the profitability of our insurance subsidiaries. We must comply with numerous constraints on our minimum capital positions. These constraints drive the requirements for capital adequacy for both AIG and the individual businesses and are based on internally-defined risk tolerances, regulatory requirements, rating agency and creditor expectations and business needs. Actual capital levels are monitored on a regular basis, and using ERM’s stress testing methodology, we evaluate the capital impact of potential macroeconomic, financial and insurance stresses in relation to the relevant capital constraints of both AIG and our insurance subsidiaries.
• approximately $712 million in the aggregate to pay dividends of $0.125 per share on AIG Common Stock in each of the four quarters of 2014;
The DIB portfolio is being wound down and is managed with the objective of ensuring that at all times it maintains the liquidity we believe is necessary to meet all of its liabilities as they come due, even under stress scenarios, and to maximize returns consistent with our risk management objectives. We are focused on meeting the DIB’s liquidity needs, including the need for contingent liquidity arising from collateral posting for debt positions of the DIB, without relying on resources beyond the DIB. As part of this program management, we may from time to time access the capital markets, including issuing and repurchasing debt, and selling assets on an opportunistic basis, in each case subject to market conditions. If the DIB’s risk target is breached, we expect to take appropriate actions to increase the DIB’s liquidity sources or reduce liquidity requirements to maintain the risk target, although no assurance can be given that this can be achieved under then-prevailing market conditions. Any additional liquidity shortfalls would need to be funded by AIG Parent.
Insurance and investment contract liabilities, including GIC liabilities, relate to our Life Insurance Companies. These liabilities include various investment-type products with contractually scheduled maturities, including periodic payments of a term certain
A key component of our Risk Appetite Framework is having a process in place that establishes and maintains appropriate limits on the material risks identified for our core businesses and allows monitoring and meeting of both internal and external stakeholder’s expectations. Our objectives include:
• Level III Limits monitor risk utilization on the regional or local level and are developed to address any specific requirements by regulators and rating agencies for that region not captured by the Level I and Level II limits. Level 3 Limits are reported at the local entity BU RCC.
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 stress testing framework to measure our quantifiable risks. This framework is built on our existing ERM stress testing methodology for both insurance and non-insurance operations. The framework measures risk over multiple time horizons and under different levels of stress. We develop a range of stress scenarios based both on internal experience and regulatory guidance. The stress tests are intended to ensure that sufficient resources for our insurance company subsidiaries and the consolidated company are available under both idiosyncratic and systemic market stress conditions.
Foreign exchange (FX) rates. We are a globally diversified enterprise with significant income, assets and liabilities denominated in, and significant capital deployed in, a variety of currencies. Changes in FX rates can affect the valuation of a broad range of balance sheet and income statement items as well as the settlement of cash flows exchanged in specific transactions.
• The effects of various run-off claims management strategies that have been developed by AIG’s run-off unit.
If the asbestos and environmental reserves develop deficiently, resulting deficiencies could have an adverse effect on our future results of operations for an individual reporting period.
With respect to known environmental claims, we established over two decades ago a specialized environmental claims unit, which investigates and adjusts all such environmental claims. This unit evaluates environmental claims utilizing a claim-by-claim approach that involves a detailed review of individual policy terms and exposures. Because each policyholder presents different liability and coverage issues, we generally evaluate exposure on a policy-by-policy basis, considering a variety of factors such as known facts, current law, jurisdiction, policy language and other factors that are unique to each policy. Quantitative techniques must be supplemented by subjective considerations, including management judgment. Each claim is reviewed at least semi-annually utilizing the aforementioned approach and adjusted as necessary to reflect the current information.
• whether the balance is in dispute or subject to legal collection;
BET Binomial Expansion Technique A model that generates expected loss estimates for CDO tranches and derives a credit rating for those tranches.
Master netting agreement An agreement between two counterparties who have multiple derivative contracts with each other that provides for the net settlement of all contracts, as well as cash collateral, through a single payment, in a single currency, in the event of default on or upon termination of any one contract.
Condensed Financial Information of Registrant at December 31, 2014 and 2013 and for the years ended December 31, 2014, 2013 and 2012
Policy fees related to features accounted for as embedded derivatives in variable annuity products, including guaranteed minimum withdrawal benefits and guaranteed minimum account value benefits, are included in the fair value measurement of embedded derivatives. Effective December 31, 2014, we reclassified fees related to these embedded derivatives to Net realized capital gains, with no effect to the fair value measurement of the embedded derivatives, Income from continuing operations, Net income attributable to AIG, or Shareholders’ equity. Accordingly, a portion of prior period policy fees have been reclassified to Net realized capital gains to conform to the current period presentation. See Note 14 herein for our accounting policy and Note 5 for a discussion of the fair value measurement of embedded policy derivatives, including policy on classification of fees.
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, and restricted cash.
Retirement and Life products are distributed through a unified multi-channel distribution network that includes banks, broker-dealers, independent marking organizations, financial advisors, independent insurance agents and career agents. Personal insurance products are distributed primarily through agents and brokers, as well as through direct marketing and partner organizations.
The degree of judgment used in measuring the fair value of financial instruments generally inversely correlates with the level of observable valuation inputs. We maximize the use of observable inputs and minimize the use of unobservable inputs when
With respect to embedded policy derivatives in our equity-indexed annuity and life contracts, option pricing models are used to estimate fair value, taking into account assumptions for future equity index growth rates, volatility of the equity index, future interest rates, and determinations on adjusting the participation rate and the cap on equity-indexed credited rates in light of market conditions and policyholder behavior assumptions. These methodologies incorporate an explicit risk margin to take into consideration market participant estimates of projected cash flows and policyholder behavior.
We also incorporate our own risk of non-performance in the valuation of the embedded policy derivatives associated with variable annuity and equity-indexed annuity and life contracts. Expected cash flows are discounted using the interest rate swap curve (swap curve), which is commonly viewed as being consistent with the credit spreads for highly-rated financial institutions (S&P AA-rated or above). A swap curve shows the fixed-rate leg of a non-complex swap against the floating rate (for example, LIBOR) leg of a related tenor. The non-performance risk adjustment reflects a market participant’s view of our claims-paying ability by incorporating an additional spread to the swap curve used to value embedded policy derivatives.
In addition to calculating an estimate of the fair value of the super senior CDO security referenced in the CDSs using our internal model, we also consider the price estimates for the super senior CDO securities provided by third parties, including counterparties to these transactions, to validate the results of the model and to determine the best available estimate of fair value. In determining the fair value of the super senior CDO security referenced in the CDSs, we use a consistent process that considers all available pricing data points and eliminates the use of outlying data points. When pricing data points are within a reasonable range an averaging technique is applied.
An increase in recovery rates and diversity score will decrease the fair value of the liability. An increase in the weighted average life will increase the fair value measurement of the liability.
Fixed maturity and equity securities classified as available for sale are carried at fair value. Unrealized gains and losses from available for sale investments in fixed maturity and equity securities are reported as a separate component of Accumulated other comprehensive income, net of deferred policy acquisition costs and deferred income taxes, in shareholders’ equity. Realized and unrealized gains and losses from fixed maturity and equity securities measured at fair value at our election are reflected in Net investment income (for insurance subsidiaries) or Other income (for Corporate and Other). Investments in fixed maturity and equity securities are recorded on a trade-date basis.
Certain hedge funds, private equity funds, affordable housing partnerships and other investment partnerships for which we have elected the fair value option are reported at fair value with changes in fair value recognized in Net investment income with the exception of investments of AIG’s Corporate and Other category, for which such changes are reported in Other income. Other investments in hedge funds, private equity funds, affordable housing partnerships and other investment partnerships in which our insurance operations do not hold aggregate interests sufficient to exercise more than minor influence over the respective partnerships are reported at fair value with changes in fair value recognized as a component of Accumulated other comprehensive income. These investments are subject to other-than-temporary impairment evaluations (see discussion below on evaluating equity investments for other-than-temporary impairment). The gross unrealized loss recorded in Other comprehensive income on such investments was $56 million and $15 million at December 31, 2014 and 2013, respectively, the majority of which pertains to investments in private equity funds and hedge funds that have been in continuous unrealized loss positions for less than 12 months.
At December 31, 2013, our secured financing transactions also included those that involve the transfer of securities to financial institutions in exchange for cash or other liquid collateral. Securities transferred by us under these financing transactions may be sold or repledged by the counterparties. As collateral for the securities transferred by us, counterparties transfer assets to us, such as cash or high quality fixed maturity securities. Collateral levels are monitored daily and are generally maintained at an agreed-upon percentage of the fair value of the transferred securities during the life of the transactions. When we receive fixed maturity securities as collateral, we do not have the right to sell or repledge this collateral unless an event of default occurs by the counterparties. At the termination of the transactions, we and our counterparties are obligated to return the collateral provided and the securities transferred, respectively.
We also enter into agreements in which securities are purchased by us under agreements to resell (reverse repurchase agreements), which are accounted for as secured financing transactions and reported as Short-term investments or Other assets, depending on their terms. These agreements are recorded at their contracted resale amounts plus accrued interest, other than those that are accounted for at fair value. Such agreements entered into by the DIB are carried at fair value based on market observable interest rates. In all reverse repurchase transactions, we take possession of or obtain a security interest in the related securities, and we have the right to sell or repledge this collateral received.
(a) In 2014 and 2013, the Net of Reinsurance amount reflects the cession under the June 17, 2011 transaction with National Indemnity Company (NICO) of $1.5 billion and $1.6 billion, respectively.
We use foreign currency denominated debt and cross-currency swaps as hedging instruments in net investment hedge relationships to mitigate the foreign exchange risk associated with our non-U.S. dollar functional currency foreign subsidiaries. We assess the hedge effectiveness and measure the amount of ineffectiveness for these hedge relationships based on changes in spot exchange rates. For the years ended December 31, 2014, 2013, and 2012 we recognized gain of $156 million, and losses of $38 million and $74 million, respectively, included in Change in foreign currency translation adjustments in Other comprehensive income related to the net investment hedge relationships.
Our gross loss reserves before reinsurance and discount are net of contractual deductible recoverable amounts due from policyholders of approximately $12.4 billion and $12.0 billion at December 31, 2014 and 2013, respectively. These recoverable amounts are related to certain policies with high deductibles (primarily for U.S. commercial casualty business) where we manage and pay the entire claim on behalf of the insured and are reimbursed by the insured for the deductible portion of the claim. At December 31, 2014 and 2013, we held collateral totaling $9.4 billion and $9.0 billion, respectively, for these deductible recoverable amounts, consisting primarily of letters of credit and trust agreements.
The net adverse development includes loss-sensitive business, for which we recognized $105 million, $89 million and $54 million loss-sensitive premium adjustments for the years ended December 31, 2014, 2013 and 2012, respectively.
• Effective for the fourth quarter of 2013, our Pennsylvania regulator approved use of a consistent discount rate (U.S. Treasury rate plus a liquidity premium) to all of our workers’ compensation reserves in our Pennsylvania-domiciled companies, as well as our use of updated payout patterns specific to our primary and excess workers compensation portfolios. Prior to this change, workers’ compensation reserves held by a Pennsylvania-domiciled insurer were discounted as follows: i) For loss reserves associated with accident year 2001 and prior accident years, a prescribed discount factor based on a rate of 6 percent and industry payout patterns, were applied, ii) For loss reserves associated with accident year 2002 and subsequent accident years, a rate of 4.25 percent and our own payout patterns were applied; and iii) For a portion of loss reserves comprising excess workers' compensation reserves that were assumed into a Pennsylvania-domiciled insurer from New York-domiciled insurers during 2011, we applied New York discounting rules, which include a prescribed rate of five percent on case reserves only (no discounting of IBNR reserves).
The following assumptions and methodology were used to determine the GMDB liability at December 31, 2014:
On May 19, 2009, the lead plaintiff in the Consolidated 2008 Securities Litigation filed a consolidated complaint on behalf of purchasers of AIG Common Stock during the alleged class period of March 16, 2006 through September 16, 2008, and on behalf of purchasers of various AIG securities offered pursuant to AIG’s shelf registration statements. The consolidated complaint alleges that defendants made statements during the class period in press releases, AIG’s quarterly and year-end filings, during conference calls, and in various registration statements and prospectuses in connection with the various offerings that were materially false and misleading and that artificially inflated the price of AIG Common Stock. The alleged false and misleading statements relate to, among other things, the Subprime Exposure Issues. The consolidated complaint alleges violations of Sections 10(b) and 20(a) of the Exchange Act and Sections 11, 12(a)(2), and 15 of the Securities Act. On August 5, 2009, defendants filed motions to dismiss the consolidated complaint, and on September 27, 2010, the Court denied the motions to dismiss.
In the normal course of business, we enter into commitments to invest in limited partnerships, private equity funds and hedge funds and to purchase and develop real estate in the U.S. and abroad. These commitments totaled $2.5 billion at December 31, 2014.
Through registered public offerings, the Department of the Treasury disposed of all of its ownership of AIG Common Stock as of December 31, 2012, from ownership of approximately 92 percent (1.7 billion shares) prior to the completion of the first registered public offering initiated by the Department of the Treasury as selling shareholder in May 2011. During 2012, the Department of the Treasury, as selling shareholder, completed registered public offerings of AIG Common Stock on March 13 (the March Offering), May 10 (the May Offering), August 8 (the August Offering), September 14 (the September Offering) and December 14 (the December Offering). We participated as a purchaser in the first four 2012 offerings. Each of these purchases was authorized by our Board of Directors.
* Dilutive shares primarily result from share-based employee compensation plans and a weighted average portion of the warrants issued to AIG shareholders as part of the recapitalization in January 2011. The number of shares excluded from diluted shares outstanding were 0.3 million, 38 million and 78 million for the years ended December 31, 2014, 2013 and 2012, respectively, because the effect of including those shares in the calculation would have been anti-dilutive.
Largely as a result of these restrictions, approximately $45.8 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, 2014.
The SICO Plans provide that shares of AIG Common Stock currently held by SICO are set aside for the benefit of the participant and distributed upon retirement. The SICO Board of Directors currently may permit an early payout of shares under certain circumstances. Prior to payout, the participant is not entitled to vote, dispose of or receive dividends with respect to such shares, and shares are subject to forfeiture under certain conditions, including but not limited to the participant’s termination of employment with us prior to normal retirement age. A significant portion of the awards under the SICO Plans vest the year after the participant reaches age 65, provided that the participant remains employed by us through age 65. The portion of the awards for which early payout is available vests on the applicable payout date.
(b) Represents target number of PSUs granted, and does not reflect potential increases or decreases that could result from the final outcome of the performance goals to be determined after the applicable performance period ends.
Share-based cash-settled awards are recorded as liabilities until the final payout is made or the award is replaced with a stock-settled award. Compensation expense is recognized over the vesting periods, unless the award is fully vested on the grant date in which case the entire award value is immediately recognized as expense.
(b) Includes non-qualified unfunded plans of which the aggregate projected benefit obligation was $325 million and $276 million for the U.S. and $295 million and $265 million for the non-U.S. at December 31, 2014 and 2013, respectively.
A Schedule 13G/A filed February 17, 2015 reports aggregate ownership of 75,755,659 shares, or approximately 5.3 percent (based on the AIG Common Stock outstanding, as adjusted to reflect the warrants owned), of AIG Common Stock and warrants (51,283,896 shares plus 24,471,763 warrants) as of December 31, 2014, including securities beneficially owned, in the aggregate, by Bruce R. Berkowitz and various investment vehicles managed by Fairholme Capital Management, L.L.C.
A Schedule 13G filed on February 11, 2015 reports aggregate ownership of 71,820,823 shares, or approximately 5.1 percent (based on the AIG Common Stock outstanding) of AIG Common Stock as of December 31, 2014, by The Vanguard Group, Inc. and various subsidiaries thereof.
As a result of sales in the ordinary course of business to manage the investment portfolio and other transactions during the year ended December 31, 2014, remaining U.S. Life Insurance Companies capital loss carryforwards were realized prior to their expiration. This, together with the changes in market conditions, resulted in a conclusion that deferred tax assets related to unrealized tax losses in the U.S. Life Insurance Companies’ available for sale portfolio will more-likely-than-not be realized. Accordingly, the related deferred tax asset valuation allowance was released.
* Net income attributable to AIG for the three-month period ended December 31, 2013 includes $327 million of net charges primarily related to income taxes to correct prior 2013 quarters presented. Such amounts are not material to any period presented.