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ITEM 8 / NOTE 10. DEFERRED POLICY ACQUISITION COSTS.....................................................................................................................................................................................10. DEFERRED POLICY ACQUISITION COSTS..............................................................................................................................................................................................Deferred policy acquisition costs represent those costs that are incremental and directly related to the successfulacquisition of new or renewal of existing insurance contracts. We defer incremental costs that result directly from,and are essential to, the acquisition or renewal of an insurance contract. Such deferred policy acquisition costsgenerally include agent or broker commissions and bonuses, premium taxes, and medical and inspection fees thatwould not have been incurred if the insurance contract had not been acquired or renewed. Each cost is analyzed toassess whether it is fully deferrable. We partially defer costs, including certain commissions, when we do not believethat the entire cost is directly related to the acquisition or renewal of insurance contracts.We also defer a portion of employee total compensation and payroll-related fringe benefits directly related to timespent performing specific acquisition or renewal activities, including costs associated with the time spent onunderwriting, policy issuance and processing, and sales force contract selling. The amounts deferred are derivedbased on successful efforts for each distribution channel and/or cost center from which the cost originates.Advertising costs related to the issuance of insurance contracts that meet the direct-advertising criteria are deferredand amortized as part of DAC.Short-duration insurance contracts: Policy acquisition costs are deferred and amortized over the period inwhich the related premiums written are earned, generally 12 months. DAC is grouped consistent with the manner inwhich the insurance contracts are acquired, serviced and measured for profitability and is reviewed for recoverabilitybased on the profitability of the underlying insurance contracts. Investment income is anticipated in assessing therecoverability of DAC. We assess the recoverability of DAC on an annual basis or more frequently if circumstancesindicate an impairment may have occurred. This assessment is performed by comparing recorded net unearnedpremiums and anticipated investment income on in-force business to the sum of expected claims, claims adjustmentexpenses, unamortized DAC and maintenance costs. If the sum of these costs exceeds the amount of recorded netunearned premiums and anticipated investment income, the excess is recognized as an offset against the assetestablished for DAC. This offset is referred to as a premium deficiency charge. Increases in expected claims andclaims adjustment expenses can have a significant impact on the likelihood and amount of a premium deficiencycharge.Long-duration insurance contracts: Policy acquisition costs for participating life, traditional life and accident andhealth insurance products are generally deferred and amortized, with interest, over the premium paying period. Policyacquisition costs and policy issuance costs related to universal life, and investment-type products (investmentorientedproducts) are deferred and amortized, with interest, in relation to the incidence of estimated gross profits tobe realized over the estimated lives of the contracts. Estimated gross profits are composed of net investment income,net realized investment gains and losses, fees, surrender charges, expenses, and mortality and morbidity gains andlosses.We use a ‘‘reversion to the mean’’ methodology, which allows us to maintain our long-term assumptions, while alsogiving consideration to the effect of deviations from these assumptions occurring in the current period. A DACunlocking is performed when management determines that key assumptions (e.g. market return, surrender rates,etc.) should be modified. The DAC asset is recalculated using the new assumptions. The use of a reversion to themean assumption is common within the industry; however, the parameters used in the methodology are subject tojudgment and vary within the industry. If estimated gross profits change significantly, DAC is recalculated using thenew assumptions. Any resulting adjustment is included in income as an adjustment to DAC. DAC is groupedconsistent with the manner in which the insurance contracts are acquired, serviced and measured for profitability andis reviewed for recoverability based on the current and projected future profitability of the underlying insurancecontracts.The DAC for investment-oriented products is also adjusted for changes in estimated gross profits that result fromchanges in the net unrealized gains or losses on fixed maturity and equity securities available for sale. Because fixedmaturity and equity securities available for sale are carried at aggregate fair value, an adjustment is made to DACequal to the change in DAC amortization that would have been recorded if such securities had been sold at theirstated aggregate fair value and the proceeds reinvested at current yields. For long-duration traditional business, ifsuch reinvestment would not be sufficient to recover DAC and meet policyholder obligations an adjustment to DACand additional future policy benefits for those products is recorded using current best estimates that incorporate areview of assumptions regarding mortality, morbidity, persistency, maintenance expenses and investment returns...................................................................................................................................................................................................................................270 AIG 2012 Form 10-K