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ITEM 7 / RESULTS OF OPERATIONS.....................................................................................................................................................................................include investment spreads, net realized investment gains and losses, fees, surrender charges, expenses andmortality gains and losses. Emerging actual gross profits are used to true up the amortization of DAC, VOBA andSIA each quarter. In addition, future assumptions are reviewed to determine whether they should be modified. If so,the DAC, VOBA and SIA assets may be recalculated and adjusted to reflect the updated assumptions. AIG Life andRetirement completed its comprehensive annual review of DAC assumptions in the fourth quarter of 2012 andadjusted the assumption for future fixed annuity surrender rates to be more consistent with recent experience that isexpected to continue as long as interest rates remain relatively low.Other acquisition and insurance expenses increased in 2012 due to higher marketing and distribution expensesassociated with growth initiatives for variable annuities and group retirement products.2011 and 2010 ComparisonAIG Life and Retirement Operating Income..............................................................................................................................................................................................Operating income decreased in 2011 due to lower net investment income, higher DAC amortization and higherpolicyholder benefit expense in its variable annuity business due to separate account performance, and an increasein death claim reserves.Policy fees were essentially flat from 2010.Net investment income decreased in 2011 compared to 2010 reflecting lower base yields of 12 basis points asinvestment purchases in late 2010 and 2011 were made at yields lower than the weighted average yields of theexisting base portfolio. Net investment income also decreased due to a $471 million decrease in fair value gains onML II, $196 million lower call and tender income, $163 million of impairment charges on investments in leasedcommercial aircraft and a $121 million decrease in private equity and hedge funds income. The lower yields werepartially offset by an increase in income from the reinvestment of significant amounts of cash and short terminvestments during 2011.Other income increased due to the previously discussed legal settlement proceeds of $226 million in 2011.Policyholder benefits and claims incurred increased as a result of reserve charges for death claims not submitted tous in the normal course of business and higher reserves for guaranteed death benefits in our variable annuityproducts as a result of less favorable separate account performance in 2011 as compared to 2010.Other acquisition and insurance expenses declined due to legal expense accruals and state guaranty fundassessments which were higher in 2010, as well as a reduction in the cost of letters of credit related to reinsurance.Life Insurance Operating IncomeLife Insurance operating income decreased in 2011 due to lower net investment income and an increase in deathclaim reserves, partially offset by lower DAC amortization due to updating actuarial assumptions in 2010 principallyrelated to mortality and surrender rates.Policyholder fees declined primarily as a result of updating certain assumptions in 2010 related to universal life anddeferred annuity business, which resulted in a $58 million increase in fee income.Net investment income decreased in 2011 compared to 2010 reflecting lower base yields as investment purchases inlate 2010 and 2011 were made at yields lower than the weighted average yields of the existing base portfolio. Netinvestment income also decreased due to a $149 million decrease in fair value gains on ML II, $126 million lower calland tender income and $50 million of impairment charges on investments in leased commercial aircraft. The loweryields were partially offset by an increase in income from the reinvestment of significant amounts of cash and shortterm investments during 2011.Policyholder benefits and claims incurred increased in 2011 reflecting an increase in reserves for death claims. AIGLife and Retirement recorded an increase of approximately $202 million in the estimated reserves for incurred but notreported death claims in 2011 in conjunction with the use of the Social Security Death Master File (SSDMF) toidentify potential claims not yet filed with its life insurance companies...................................................................................................................................................................................................................................AIG 2012 Form 10-K 103