2007 Annual Report - AIG.com

American International Group, Inc. and Subsidiaries
Management’s Discussion and Analysis of
Financial Condition and Results of Operations Continued
Liquidity
excess casualty, expected loss ratios generally are utilized for
at least the three most recent accident years.
AIG manages liquidity at both the subsidiary and parent company ( Loss development factors: used to project the reported losses
levels. At December 31, 2007, AIG’s consolidated invested
for each accident year to an ultimate amount.
assets, primarily held by its subsidiaries, included $65.6 billion in ( Reinsurance recoverable on unpaid losses: the expected recovcash
and short-term investments. Consolidated net cash provided eries from reinsurers on losses that have not yet been
from operating activities in 2007 amounted to $35.2 billion. At reported and/or settled.
both the subsidiary and parent company level, liquidity management
activities are intended to preserve and enhance funding Future Policy Benefits for Life and Accident and Health Contracts
stability, flexibility, and diversity through a wide range of potential (Life Insurance & Retirement Services):
operating environments and market conditions. AIG’s primary ( Interest rates: which vary by geographical region, year of
sources of cash flow are dividends and other payments from its issuance and products.
regulated and unregulated subsidiaries, as well as issuances of ( Mortality, morbidity and surrender rates: based upon actual
debt securities. Primary uses of cash flow are for debt service, experience by geographical region modified to allow for variation
subsidiary funding, shareholder dividend payments and common in policy form, risk classification and distribution channel.
stock repurchases. As a result of disruption in the credit markets
Deferred Policy Acquisition Costs (Life Insurance & Retirement
during 2007, AIG took steps to enhance the liquidity of its
Services):
portfolios, including increasing the liquidity of the collateral in the
( Recoverability: based on current and future expected profitabilsecurities
lending program. Management believes that AIG’s liquid
ity, which is affected by interest rates, foreign exchange rates,
assets, cash provided by operations and access to the capital
mortality experience and policy persistency.
markets will enable it to meet its anticipated cash requirements,
including the funding of increased dividends under AIG’s new Deferred Policy Acquisition Costs (General Insurance):
dividend policy. ( Recoverability: based upon the current terms and profitability of
the underlying insurance contracts.
Critical Accounting Estimates
Estimated Gross Profits (Life Insurance & Retirement Services):
The preparation of financial statements in conformity with account- ( Estimated gross profits: to be realized over the estimated
(
(
ing principles generally accepted in the United States of America duration of the contracts (investment-oriented products) affect
requires the application of accounting policies that often involve a the carrying value of DAC, unearned revenue liability and
significant degree of judgment. AIG considers that its accounting associated amortization patterns under FAS 97, ‘‘Accounting
policies that are most dependent on the application of estimates and Reporting by Insurance Enterprises for Certain Longand
assumptions, and therefore viewed as critical accounting
Duration Contracts and for Realized Gains and Losses from the
estimates, to be those relating to reserves for losses and loss Sale of Investments’’ (FAS 97); and Sales Inducement Assets
expenses, future policy benefits for life and accident and health under American Institute of Certified Public Accountants (AICPA)
contracts, recoverability of DAC, estimated gross profits for
Statement of Position (SOP) 03-1, ‘‘Accounting and Reporting
investment-oriented products, fair value measurements of certain by Insurance Enterprises for Certain Nontraditional Long-Durafinancial
assets and liabilities, other-than-temporary impairments, tion Contracts and for Separate Accounts’’ (SOP 03-1). Estithe
allowance for finance receivable losses and flight equipment mated gross profits include investment income and gains and
recoverability. These accounting estimates require the use of
losses on investments less required interest, actual mortality
assumptions about matters, some of which are highly uncertain at and other expenses.
the time of estimation. To the extent actual experience differs
Fair Value Measurements of Financial Instruments:
from the assumptions used, AIG’s results of operations would be
AIG measures financial instruments in its trading and available
directly affected.
for sale securities portfolios, together with securities sold but not
Throughout this Management’s Discussion and Analysis of
yet purchased, certain hybrid financial instruments, and derivative
Financial Condition and Results of Operations, AIG’s critical
assets and liabilities at fair value. The fair value of a financial
accounting estimates are discussed in detail. The major categoinstrument
is the amount that would be received to sell an asset
ries for which assumptions are developed and used to establish
or paid to transfer a liability in an orderly transaction between
each critical accounting estimate are highlighted below.
market participants at the measurement date.
Reserves for Losses and Loss Expenses (General Insurance):
The degree of judgment used in measuring the fair value of
financial instruments generally correlates with the level of pricing
Loss trend factors: used to establish expected loss ratios for
subsequent accident years based on premium rate adequacy observability. Financial instruments with quoted prices in active
and the projected loss ratio with respect to prior accident markets generally have more pricing observability and less
years.
judgment is used in measuring fair value. Conversely, financial
instruments traded in other than active markets or that do not
Expected loss ratios for the latest accident year: in this case,
accident year 2007 for the year-end 2007 loss reserve
have quoted prices have less observability and are measured at
analysis. For low-frequency, high-severity classes such as fair value using valuation models or other pricing techniques that
38 AIG 2007 Form 10-K