INSURANCE LIABILITIES

12 Months Ended

Dec. 31, 2015

LIABILITY FOR UNPAID CLAIMS AND CLAIMS ADJUSTMENT EXPENSE, FUTURE POLICY BENEFITS FOR LIFE AND ACCIDENT AND HEALTH INSURANCE CONTRACTS, AND POLICYHOLDER CONTRACT DEPOSITS

LIABILITY FOR UNPAID CLAIMS AND CLAIMS ADJUSTMENT EXPENSE, FUTURE POLICY BENEFITS FOR LIFE AND ACCIDENT AND HEALTH INSURANCE CONTRACTS, AND POLICYHOLDER CONTRACT DEPOSITS

12. INSURANCE LIABILITIES

Liability for Unpaid Losses and Loss Adjustment Expenses

The liability for unpaid losses and loss adjustment expenses represents the accumulation of estimates of unpaid claims, including estimates for claims incurred but not reported and claim adjustments expenses, less applicable discount for future investment income. We continually review and update the methods used to determine loss reserve estimates and to establish the resulting reserves. Any adjustments resulting from this review are reflected currently in pre-tax income. Because these estimates are subject to the outcome of future events, changes in estimates are common given that loss trends vary and time is often required for changes in trends to be recognized and confirmed. Reserve changes that increase previous estimates of ultimate cost are referred to as unfavorable or adverse development or reserve strengthening. Reserve changes that decrease previous estimates of ultimate cost are referred to as favorable development.

Our gross loss reserves before reinsurance and discount are net of contractual deductible recoverable amounts due from policyholders of approximately $12.6 billion and $12.4 billion at December 31, 2015 and 2014, respectively. These recoverable amounts are related to certain policies with high deductibles (in excess of high dollar amounts retained by the insured through self-insured retentions or deductibles each referred to generically as “deductibles”), primarily for U.S. commercial casualty business. With respect to the deductible portion of the claim, the Non-life Insurance Companies manage and pay the entire claim on behalf of the insured and are reimbursed by the insured for the deductible portion of the claim. At December 31, 2015 and 2014, we held collateral of approximately $9.6 billion and $9.4 billion, respectively, for these deductible recoverable amounts, consisting primarily of letters of credit and trust agreements.

The following table presents the reconciliation of activity in the Liability for unpaid losses and loss adjustment expenses:

Years Ended December 31,
(in millions)		2015		2014		2013
Liability for unpaid losses and loss adjustment expenses, beginning of year	$	77,260	$	81,547	$	87,991
Reinsurance recoverable		(15,648)		(17,231)		(19,209)
Net liability for unpaid losses and loss adjustment expenses, beginning of year		61,612		64,316		68,782
Foreign exchange effect		(1,429)		(1,061)		(617)
Dispositions		-		-		(79)
Changes in net loss reserves due to retroactive asbestos reinsurance transaction		20		141		22
Total		60,203		63,396		68,108
Losses and loss adjustment expenses incurred:
Current year		20,308		21,279		22,171
Prior years, excluding discount		4,119		703		557
Prior years, discount charge (benefit)		(71)		478		(309)
Total		24,356		22,460		22,419
Losses and loss adjustment expenses paid^*:
Current year		5,751		6,358		7,431
Prior years		18,205		17,886		18,780
Total		23,956		24,244		26,211
Balance, end of year:
Net liability for unpaid losses and loss adjustment expenses		60,603		61,612		64,316
Reinsurance recoverable		14,339		15,648		17,231
Total	$	74,942	$	77,260	$	81,547

* Includes amounts related to dispositions through the date of disposition.

The net adverse development includes loss-sensitive business, for which we recognized (return) additional premiums on loss sensitive business of $(49) million, $105 million and $89 million for the years ended December 31, 2015, 2014and 2013, respectively.

Each quarter, we conduct a series of actuarial reviews to reassess the reasonableness of our carried reserves. These reviews are conducted for each class of business, and consist of hundreds of individual analyses. We consider data and information arising since the prior review and adjust, as appropriate, the methods and assumptions used in the latest actuarial reviews. Our analyses produce a range of indications from various methods, from which we select our best estimate.

For 2015, the adverse development of prior year losses is primarily a result of the following:

Excess Casualty – U.S. & Canada experienced $1.5 billion of adverse development largely driven by worse than expected loss emergence reported in 2015, reflecting worsening trends in the number and nature of high severity losses in both general liability and umbrella auto liability, primarily for U.S. risks. We reacted to the adverse emergence by updating our assumptions about loss severity, loss development patterns, and expected loss ratios for the most recent accident years.
Primary Casualty – U.S. & Canada experienced $1.1 billion of adverse development. $540 million related to workers’ compensation policies with risk sharing features to reflect estimated increased losses and reduced expectations of future recoveries from our insureds through these risk-sharing features. Risk-sharing features, include high deductibles, self-insured retentions or retrospective rating features. We also experienced adverse development of $146 million in primary general liability due to adverse emergence of claims in the construction sector; $144 million in primary auto liability due to observed increases in both the frequency and severity of claims; $100 million for future claim handling expenses related to existing loss reserves, and $100 million in workers’ compensation for coverages sold to government contractors in U.S. and non U.S. military installations as a result of adverse loss emergence in recent accident years.
Financial Lines – U.S. & Canada experienced $579 million of adverse development related to development of several reported claims above expectations, in D&O and professional liability principally related to accident years 2006 through 2010.
Run-off insurance lines experienced $727 million of adverse development largely driven by $281 million in asbestos and environmental for accident years 1986 & prior and $272 million of other run-off. Reasons for this development are as follows:

Asbestos coverage has been excluded from AIG policies commencing in 1985. Most of AIG’s asbestos reserves are ceded to National Indemnity Company (NICO) under a retrospective reinsurance arrangement entered into in 2011. However, certain asbestos-related exposures are not subject to the NICO agreement, including asbestos exposures for which we have negotiated fixed payment schedules, and third party reinsurance assumed policies. The reported claim activity on the assumed claims has increased in the last year. As a result, we modified certain of our loss-reserve-related assumptions to better reflect this AIG-specific experience as well as consideration of recent industry-wide trends regarding expanding coverage theories for liability. As a result, we increased our 2015 reserves by $164 million and by $117 million for Asbestos and Environmental, respectively.
Run-off lines experienced $272 million of adverse development based on updated assumptions about future loss development.

In 2014, the increase in prior years’ loss reserves of $703 million included $550 million, $124 million, $182 million, $109 million, and $(102) million related to Primary Casualty – U.S. & Canada, Asbestos and environmental (1986 and prior), Financial Lines – International, Healthcare, and Natural Catastrophes – U.S. & Canada, respectively.

In 2013, the increase in prior years’ loss reserves of $557 million includes $498 million, $238 million, $(144) million, and $(54) million related to Primary Casualty – U.S. & Canada, Asbestos and environmental (1986 and prior), Excess Casualty – U.S. & Canada, and Healthcare, respectively.

Asbestos and Environmental Run-off Reserves

At December 31, 2015 and 2014, our net liability for unpaid loss and loss adjustment expenses included $722 million and $573 million, respectively, for asbestos and environmental-related claims (net of reinsurance, including retroactive reinsurance). We cede the bulk of AIG Property Casualty’s net domestic asbestos liabilities under a 2011 retroactive reinsurance agreement with National Indemnity Company (NICO) with an aggregate limit of $3.5 billion. Reinsurance recoverables related to this agreement are $1.8 billion and $1.5 billion, respectively, at December 31, 2015 and 2014, respectively. Under retroactive reinsurance accounting, contractual gains are deferred and amortized into income over the settlement period of the underlying reinsured claims. During 2015, 2014 and 2013, we recognized approximately $233 million, $0 and $72 million, respectively, of additional recoveries under the NICO agreement for which the income statement benefit was deferred. The expense related to this increase in the deferred gain liability is reported in Other income/expense and is therefore excluded from net losses incurred.

Reserves for asbestos and environmental claims cannot be estimated using conventional reserving techniques such as those that rely on historical accident year loss development factors. The methods used to determine asbestos and environmental loss estimates and to establish the resulting reserves are continually reviewed and updated by management.

Various factors contribute to the complexity and difficulty in determining the future development of claims such as court resolutions and judicial interpretations which broaden the intent of the policies and scope of coverage.

We primarily base our determination of these reserves on a combination of ground-up and top-down analyses of historical claims and available insurance coverages. We consider a number of factors and recent experience, in addition to the results of both external and internal analyses, to estimate asbestos and environmental loss reserves.

Discounting of Reserves

At December 31, 2015, the liability for unpaid losses and loss adjustment expenses reflects a net loss reserve discount of $3.1 billion, including tabular and non-tabular calculations based upon the following assumptions:

Certain asbestos business that was written by Non-Life Insurance Companies is discounted, when allowed by the regulator and when payments are fixed and determinable, based on the investment yields of the companies and the payout pattern for this business.
The tabular workers’ compensation discount is calculated based on a 3.5 percent interest rate and the mortality table used in the 2007 U.S. Life Table.
The non-tabular workers’ compensation discount is calculated separately for companies domiciled in New York and Pennsylvania, and follows the statutory regulations (prescribed or permitted) for each state. For New York companies, the discount is based on a five percent interest rate and the companies’ own payout patterns.
Our Delaware and Pennsylvania regulators approved use of a consistent discount rate (U.S. Treasury rate plus a liquidity premium) to all of our workers’ compensation reserves in companies domiciled in those states, as well as our use of updated payout patterns specific to our primary and excess workers compensation portfolios.
In the fourth quarter of 2015, our Pennsylvania and Delaware regulators approved an updated discount rate that we applied to our workers’ compensation loss reserves for the legal entities domiciled in those states.

The discount consists of the following: $853 million of tabular discount for workers’ compensation, $2.3 billion of non-tabular discount for workers’ compensation in the domestic operations; and $7 million — non-tabular discount for asbestos

Future Policy Benefits

Future policy benefits primarily include reserves for traditional life and annuity payout contracts, which represent an estimate of the present value of future benefits less the present value of future net premiums. Included in Future policy benefits are liabilities for annuities issued in structured settlement arrangements whereby a claimant has agreed to settle a general insurance claim in exchange for fixed payments over a fixed determinable period of time with a life contingency feature.

Future policy benefits also include certain guaranteed benefits of variable annuity products that are not considered embedded derivatives, primarily guaranteed minimum death benefits. See Note 13 for additional information on guaranteed minimum death benefits.

The liability for long-duration future policy benefits has been established including assumptions for interest rates which vary by year of issuance and product, and range from approximately 3 percent to 14 percent. Mortality and surrender rate assumptions are generally based on actual experience when the liability is established.

Policyholder Contract Deposits

The liability for Policyholder contract deposits is primarily recorded at accumulated value (deposits received and net transfers from separate accounts, plus accrued interest credited at rates ranging from 0.2 percent to 9.0 percent at December 31, 2015, less withdrawals and assessed fees). Deposits collected on investment-oriented products are not reflected as revenues, because they are recorded directly to Policyholder contract deposits upon receipt. Amounts assessed against the contract holders for mortality, administrative, and other services are included in revenues.

In addition to liabilities for universal life, fixed annuities, fixed options within variable annuities, annuities without life contingencies, funding agreements and GICs, policyholder contract deposits also include our liability for (a) certain guaranteed benefits and indexed features accounted for as embedded derivatives at fair value, (b) annuities issued in a structured settlement arrangement with no life contingency and (c) certain contracts we have elected to account for at fair value. See Note 13 herein for additional information on guaranteed benefits accounted for as embedded derivatives.

For universal life policies with secondary guarantees, we recognize certain liabilities in addition to policyholder account balances. For universal life policies with secondary guarantees, as well as other universal life policies for which profits followed by losses are expected at contract inception, a liability is recognized based on a benefit ratio of (a) the present value of total expected payments, in excess of the account value, over the life of the contract, divided by (b) the present value of total expected assessments over the life of the contract. For universal life policies without secondary guarantees, for which profits followed by losses are first expected after contract inception, we establish a liability, in addition to policyholder account balances, so that expected future losses are recognized in proportion to the emergence of profits in the earlier (profitable) years. Universal life account balances as well as these additional liabilities related to universal life products are reported within policyholder contract deposits in the Consolidated Balance Sheet.

Under a funding agreement-backed notes issuance program, an unaffiliated, non-consolidated statutory trust issues medium-term notes to investors, which are secured by GICs issued to the trust by one of our Life Insurance Companies through our Institutional Markets operating segment.

The following table presents Policyholder contract deposits of the U.S. Life Insurance Companies by product line:

At December 31,
(in millions)		2015		2014
Policyholder contract deposits:
Fixed Annuities	$	52,397	$	53,370
Group Retirement		37,865		37,693
Life		14,028		13,717
Retirement Income Solutions		13,927		10,040
Institutional Markets		9,371		9,793
Total Policyholder contract deposits	$	127,588	$	124,613

Other Policyholder Funds

Other policyholder funds include unearned revenue reserves (URR). URR consist of front-end loads on investment-oriented contracts, representing those policy loads that are non-level and typically higher in initial policy years than in later policy years. URR for investment-oriented contracts are generally deferred and amortized, with interest, in relation to the incidence of estimated gross profits (EGPs) to be realized over the estimated lives of the contracts and are subject to the same adjustments due to changes in the assumptions underlying EGPs as DAC. Amortization of URR is recorded in Policy fees.

Other policyholder funds also include provisions for future dividends to participating policyholders, accrued in accordance with all applicable regulatory or contractual provisions. Participating life business represented approximately 2.2 percent of gross insurance in force at December 31, 2015 and 2.4 percent of gross domestic premiums and other considerations in 2015. The amount of annual dividends to be paid is approved locally by the boards of directors of the Life Insurance Companies. Provisions for future dividend payments are computed by jurisdiction, reflecting local regulations. The portions of current and prior net income and of current unrealized appreciation of investments that can inure to our benefit are restricted in some cases by the insurance contracts and by the local insurance regulations of the jurisdictions in which the policies are in force.

Certain products are subject to experience adjustments. These include group life and group medical products, credit life contracts, accident and health insurance contracts/riders attached to life policies and, to a limited extent, reinsurance agreements with other direct insurers. Ultimate premiums from these contracts are estimated and recognized as revenue with the unearned portions of the premiums recorded as liabilities in Other policyholder funds. Experience adjustments vary according to the type of contract and the territory in which the policy is in force and are subject to local regulatory guidance.