2007 Annual Report - AIG.com

American International Group, Inc. and Subsidiaries
Management’s Discussion and Analysis of
Financial Condition and Results of Operations Continued
period of time subsequent to the recording of the initial loss loss development patterns will be the same as in the past, or that
reserve estimates for any accident year. Thus, there is the
they will not deviate by more than the 6 percent or 3.5 percent
potential for the reserves with respect to a number of accident amounts.
years to be significantly affected by changes in the loss cost
Excess Workers Compensation: For excess workers compensation
trends or loss development factors that were initially relied upon
business, loss costs were trended at six percent per annum. After
in setting the reserves. These changes in loss trends or loss
reviewing actual industry loss trends for the past ten years, in
development factors could be attributable to changes in inflation
AIG’s judgment, it is reasonably likely that actual loss cost trends
or in the judicial environment, or in other social or economic
applicable to the year-end 2007 loss reserve review for excess
conditions affecting claims. Thus, there is the potential for
workers compensation will range five percent lower or higher than
variations greater than the amounts cited above, either positively
this estimated loss trend. A five percent change in the assumed
or negatively.
loss cost trend would cause approximately a $425 million
D&O and Related Management Liability Classes of Business: For increase or a $275 million decrease in the net loss reserves for
D&O and related management liability classes of business, the this business. It should be emphasized that the actual loss cost
assumed loss cost trend was approximately four percent. After trend could vary significantly from this assumption, and there can
evaluating the historical loss cost trends from prior accident years be no assurance that actual loss costs will not deviate, perhaps
since the early 1990s, in AIG’s judgment, it is reasonably likely materially, by greater than five percent.
that actual loss cost trends applicable to the year-end 2007 loss For excess workers compensation business, the assumed loss
reserve review for these classes will range from negative
development factors are a critical assumption. Excess workers
11 percent to positive 19 percent, or approximately 15 percent compensation is an extremely long-tail class of business, with a
lower or higher than the assumption actually utilized in the year- much greater than normal uncertainty as to the appropriate loss
end 2007 reserve review. A 15 percent change in the assumed development factors for the tail of the loss development. After
loss cost trend for these classes would cause approximately a evaluating the historical loss development factors for prior
$550 million increase or a $500 million decrease in the net loss accident years since the 1980s, in AIG’s judgment, it is
and loss expense reserves for these classes of business. It reasonably likely that actual loss development factors will range
should be emphasized that the 15 percent deviations are not approximately 15 percent lower or higher than those factors
considered the highest possible deviations that might be ex- actually utilized in the year-end 2007 loss reserve review for
pected, but rather what is considered by AIG to reflect a
excess workers compensation. If the loss development factor
reasonably likely range of potential deviation. Actual loss cost assumptions were changed by 15 percent, the net loss reserves
trends for these classes in the early 1990s were negative for for excess workers compensation would increase or decrease by
several years, including amounts below the negative 11 percent approximately $600 million. Given the exceptionally long-tail for
cited above, whereas actual loss cost trends in the late 1990s this class of business, there is the potential for actual deviations
ran at nearly 50 percent per year for several years, vastly
in the loss development tail to exceed the deviations assumed,
exceeding the 19 percent figure cited above. Because the D&O perhaps materially.
class of business has exhibited highly volatile loss trends from
Primary Workers Compensation: For primary workers compensaone
accident year to the next, there is the possibility of an
tion, the loss cost trend assumption is not believed to be material
exceptionally high deviation.
with respect to AIG’s loss reserves. This is primarily because
For D&O and related management liability classes of business,
AIG’s actuaries are generally able to use loss development
the assumed loss development factors are also an important
projections for all but the most recent accident year’s reserves,
assumption but less critical than for excess casualty. Because
so there is limited need to rely on loss cost trend assumptions for
these classes are written on a claims made basis, the loss
primary workers compensation business.
reporting and development tail is much shorter than for excess
However, for primary workers compensation business the loss
casualty. However, the high severity nature of the claims does
development factor assumptions are important. Generally, AIG’s
create the potential for significant deviations in loss development
actual historical workers compensation loss development factors
patterns from one year to the next. After evaluating the historical
would be expected to provide a reasonably accurate predictor of
loss development factors for these classes of business for
future loss development. However, workers compensation is a
accident years since the early 1990s, in AIG’s judgment, it is
long-tail class of business, and AIG’s business reflects a very
reasonably likely that actual loss development factors will range
significant volume of losses particularly in recent accident years
approximately 6 percent lower to 3.5 percent higher than those
due to growth of the business. After evaluating the actual
factors actually utilized in the year-end 2007 loss reserve review
historical loss developments since the 1980s for this business, in
for these classes. If the loss development factor assumptions
AIG’s judgment, it is reasonably likely that actual loss developwere
changed by 6 percent and 3.5 percent, respectively, the net
ment factors will fall within the range of approximately 3.5 percent
loss reserves for these classes would be estimated to decrease
below to 8.25 percent above those actually utilized in the year-end
or increase by approximately $250 million and $125 million,
2007 loss reserve review. If the loss development factor
respectively. As noted above for excess casualty, actual historical
assumptions were changed by 3.5 percent and 8.25 percent,
loss development factors are generally used to project future loss
respectively, the net loss reserves for workers compensation
development. However, there can be no assurance that future
58 AIG 2007 Form 10-K