2007 Annual Report - AIG.com

American International Group, Inc. and Subsidiaries
Management’s Discussion and Analysis of
Financial Condition and Results of Operations Continued
DAC for Life Insurance & Retirement Services products arises
from the deferral of costs that vary with, and are directly related
to, the acquisition of new or renewal business. Policy acquisition
costs for life insurance products are generally deferred and
amortized over the premium paying period in accordance with
FAS 60. Policy acquisition costs that relate to universal life and
investment-type products are deferred and amortized, with interest
in relation to the incidence of estimated gross profits to be
realized over the estimated lives of the contracts in accordance
with FAS 97. Value of Business Acquired (VOBA) is determined at
the time of acquisition and is reported on the consolidated
balance sheet with DAC and amortized over the life of the
business, similar to DAC. AIG offers sales inducements to
contract holders (bonus interest) on certain annuity and invest-
ment contracts. Sales inducements are recognized as part of the
liability for policyholders contract deposits on the consolidated
balance sheet and are amortized over the life of the contract
similar to DAC. Total deferred acquisition and sales inducement
costs increased $549 million in 2007 compared to 2006 primarily
due to higher production in the Foreign Life Insurance operations
partially offset by lower Domestic Life Insurance & Retirement
Services sales. Total amortization expense decreased $328 mil-
lion compared to 2006. Annualized amortization expense levels in
2007 and 2006 were approximately 10 percent and 13 percent,
respectively, of the opening DAC balance. The decline in amortization
expense levels relates to changes in actuarial estimates,
which is substantially offset by related adjustments to incurred
policy losses and benefits.
comprehensive income until the bond is sold or deemed to be
other-than-temporarily impaired.
For the Domestic Life Insurance and Domestic Retirement
Services operations, the higher net realized capital losses
resulted principally from other-than-temporary impairment charges
of $1.8 billion in 2007 compared to $560 million in 2006 and
from the sale of securities in 2007 to reposition assets in certain
investment portfolios. Net realized capital losses in the Domestic
Life Insurance operations in 2007 included losses of $186 million
related to derivatives that did not qualify for hedge accounting
treatment under FAS 133 compared to a gain of $25 million in
2006. Derivatives in the Domestic Life Insurance operations
include affiliated interest rate swaps used to economically hedge
cash flows on bonds and option contracts used to economically
hedge cash flows on indexed annuity and universal life products.
The corresponding gain or loss with respect to the economically
hedged bond is deferred in accumulated other comprehensive
income until the bond is sold, matures or deemed to be other-
than-temporarily impaired. See Invested Assets — Valuation of
Invested Assets — Portfolio Review herein.
2006 and 2005 Comparison
Net realized capital gains (losses) in 2006 improved $246 million
compared to 2005 primarily due to gains on derivative instruments
primarily used to economically hedge cash flows that did
not qualify for hedge accounting treatment under FAS 133 and
related primarily to the Foreign Life Insurance & Retirement
Services operations.
Deferred Policy Acquisition Costs and Sales Inducement
Assets
78 AIG 2007 Form 10-K