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ITEM 7 / CRITICAL ACCOUNTING ESTIMATES.....................................................................................................................................................................................We also use these estimates to determine whether to adjust DAC and record additional liabilities when unrealizedgains or losses on fixed maturity and equity securities available for sale are recognized through accumulated othercomprehensive income. The determination is made at each balance sheet date, as if the securities had been sold attheir stated aggregate fair value and the proceeds reinvested at current yields. Significant unrealized appreciation oninvestments in a prolonged low interest rate environment may cause DAC to be adjusted and additional future policybenefit liabilities to be recorded through a charge directly to accumulated other comprehensive income (ie. ShadowDAC). This is included, net of tax, with the change in net unrealized appreciation (depreciation) of investments.Our future policy benefits include guaranteed minimum death benefits (GMDB). We determine the GMDBliability each period end by estimating the expected value of death benefits in excess of the projected accountbalance and recognizing the excess ratably over the accumulation period based on total expected fees. Theestimates include assumptions about interest rates, mortality rates, lapse rates and a randomly generated model ofinvestment returns. In addition to GMDB, our future policy benefits include, to a lesser extent, guaranteed minimumincome benefits (GMIB). We determine GMIB liability each period end by estimating the expected value of theperiodic income payments from annuities in excess of the projected account balance. We derive this estimate at thedate the annuity converts to regular payments, and we recognize the excess ratably over the accumulation periodbased on total expected assessments. We periodically evaluate estimates used and adjust the additional liabilitybalance, with a related charge or credit to benefit expense, if actual experience or other evidence suggests thatearlier assumptions should be revised.We also issue certain variable annuity products that offer optional guaranteed minimum withdrawal benefits(GMWB) and guaranteed minimum account value benefits (GMAV). These living benefits are embeddedderivatives that are required to be bifurcated from the host contract and carried at fair value. The fair value estimatesof the living benefit guarantees include assumptions such as equity market returns, interest rates, market volatilityand policyholder behavior. We also incorporate our own risk of non-performance in the valuation of the embeddedpolicy derivatives. See Note 6 to the Consolidated Financial Statements for information on how AIG incorporates itsown non-performance risk.We have a dynamic hedging program designed to manage economic risk exposure associated with changes in thefair value of GMWB and GMAV liabilities caused by changes in the equity markets, interest rates and market impliedvolatilities. The program utilizes hedging instruments, including derivatives such as equity options, futures contractsand interest rate swap contracts, and is designed so that changes in value of the hedging instruments move in theopposite direction of changes in the GMWB and GMAV embedded derivative liabilities. We monitor the hedgingpositions on a daily basis in relation to the change in valuation of GMWB and GMAV embedded derivative liabilities,and rebalance those positions as needed. Differences between the change in fair value of GMWB and GMAVembedded derivative liabilities and the hedging instruments can be caused by extreme and unanticipated movementsin the equity markets, interest rates and market volatility, policyholder behavior, statutory capital considerations andconstraints and the ability to purchase hedging instruments at prices consistent with the desired risk and returntrade-off. None of the derivative instruments described above are designated for hedge accounting.Approximately 56 percent of our individual variable annuity account values contain either a GMWB rider or a GMAVrider as of December 31, 2012. Declines in the equity markets, increased volatility and a sustained low interest rateenvironment increase our exposure to potential benefits under the GMWB and GMAV contracts, leading to anincrease in the existing liability for those benefits. Our exposure to the guaranteed amounts is equal to the amountby which the contract holder’s account balance is below the guaranteed withdrawal or account value amount. As ofDecember 31, 2012, our exposure to the guaranteed withdrawal and account value amount under GMWB and GMAVwas $0.9 billion and $10 million, respectively.The only way the GMWB contract holder can monetize the excess of the guaranteed amount over the account valueof the contract is through a series of withdrawals that do not exceed a specific percentage per year of theguaranteed amount. If, after the series of withdrawals, the account value is exhausted, the contract holder willreceive a series of annuity payments equal to the remaining guaranteed amount, and, for lifetime GWWB products,the annuity payments can continue beyond the guaranteed amount. The account value can also fluctuate with equitymarket returns on a daily basis resulting in increases or decreases in the excess of the guaranteed amount overaccount value.The net impact of the change in the fair value of the embedded derivative liabilities, as well as the change in the fairvalue of the derivative instruments is included in Net Realized Capital Gains (Losses)...................................................................................................................................................................................................................................190 AIG 2012 Form 10-K