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ITEM 7 / RESULTS OF OPERATIONS.....................................................................................................................................................................................Amortization of deferred acquisition costs was lower in 2011 as a result of updating mortality and surrender rateassumptions on universal life and deferred annuity business in 2010, which resulted in an $86 million increase inDAC amortization in 2010.Other acquisition and insurance expenses were essentially flat from 2010.Retirement Services Operating IncomeRetirement services operating income decreased in 2011 due to lower net investment income, higher DACamortization and higher policyholder benefit expense in its variable annuity business from equity market conditions,partially offset by higher income from legal settlements.Net investment income decreased in 2011 compared to 2010 reflecting lower base yields as investment purchases inlate 2010 and 2011. Net investment income also decreased due to a $322 million decrease in fair value gains on MLII, $70 million lower call and tender income, $113 million of impairment charges on investments in leased commercialaircraft and a $127 million decrease in private equity and hedge fund income. The lower yields were partially offsetby an increase in income from the reinvestment of significant amounts of cash and short term investments during2011.Other income increased due to the previously discussed legal settlement proceeds of $226 million in 2011 to resolvea litigation matter as discussed above.Policyholder benefits and claims incurred increased in 2011 due to the impact of lower separate accountperformance in 2011 compared to 2010.Other acquisition and insurance expenses declined due to legal expenses and state guaranty fund assessmentswhich were higher in 2010.Legal SettlementsIn December of 2012, we recorded litigation settlement income from settlements with three financial institutions whoparticipated in the creation, offering and sale of RMBS as to which AIG and its subsidiaries suffered losses eitherdirectly on their own account or in connection with their participation in AIG’s securities lending program.Changes in Fair Value of Fixed Maturity Securities Designated to Hedge Living Benefit LiabilitiesAIG Life and Retirement has a dynamic hedging program designed to manage economic risk exposure associatedwith changes in equity markets, interest rates and volatilities related to embedded derivative liabilities contained inguaranteed benefit features of variable annuities. We substantially hedge our exposure to equity markets. However,due to regulatory capital considerations, a portion of our interest rate exposure is unhedged. In 2012, we beganpurchasing U.S. Treasury bonds as a capital-efficient strategy to reduce our interest rate risk exposure over time. Asa result of decreases in interest rates on U.S. Treasury securities during 2012, the fair value of the U.S. Treasurysecurities used for hedging, net of financing costs, increased by $37 million. This was partially offset by embeddedderivative losses related to the decline in interest rates, which are reported in net realized gains (losses).Net Realized Capital Gains (Losses)Net realized capital gains increased by $624 million in 2012 as compared to 2011 due to higher gains from the saleof investments in conjunction with a program to utilize capital loss tax carryforwards and lower other-than-temporaryimpairments. The higher gains were partially offset by $557 million higher fair value losses on variable annuityembedded derivatives, which were primarily due to declining credit spreads and declines in long-term interest rates.AIG Life and Retirement reported net realized capital gains in 2011 compared to net realized capital losses in 2010.This was mainly due to a $981 million decline in other-than-temporary impairments, a decline in fair value losses onderivatives primarily used to hedge the effect of interest rate and foreign exchange movements on GIC reserves, anddeclines in the allowance for mortgage loans. These improvements were partially offset by a $465 million increase infair value losses on variable annuity embedded derivatives which were primarily driven by declines in long-terminterest rates...................................................................................................................................................................................................................................104 AIG 2012 Form 10-K