Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts

In October 2010, the Financial Accounting Standards Board (FASB) issued an accounting standard update that amends the accounting for costs incurred by insurance companies that can be capitalized in connection with acquiring or renewing insurance contracts. The standard clarifies how to determine whether the costs incurred in connection with the acquisition of new or renewal insurance contracts qualify as deferred policy acquisition costs. AIG adopted the standard retrospectively on January 1, 2012.

Policy acquisition costs represent those costs that are incremental and directly related to the successful acquisition of new or renewal insurance contracts. AIG defers incremental costs that result directly from, and are essential to, the acquisition or renewal of an insurance contract. Such costs generally include agent or broker commissions and bonuses, premium taxes, and medical and inspection fees that would not have been incurred if the insurance contract had not been acquired or renewed. Each cost is analyzed to assess whether it is fully deferrable. AIG partially defers costs, including certain commissions, when it does not believe the entire cost is directly related to the acquisition or renewal of insurance contracts.

AIG also defers a portion of employee total compensation and payroll-related fringe benefits directly related to time spent performing specific acquisition or renewal activities including costs associated with the time spent on underwriting, policy issuance and processing, and sales force contract selling. The amounts deferred are derived based 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 deferred and amortized as part of deferred policy acquisition costs.

The method AIG uses to amortize deferred policy acquisition costs for either short- or long-duration insurance contracts did not change as a result of the adoption of the standard.

The adoption of the standard resulted in a reduction to beginning of period retained earnings for the earliest period presented and a decrease in the amount of capitalized costs in connection with the acquisition or renewal of insurance contracts. Accordingly, AIG revised its historical financial statements and accompanying notes to the financial statements for the changes in deferred policy acquisition costs and associated changes in acquisition expenses and income taxes for affected entities and segments, including divested entities presented in continuing and discontinued operations.

The following tables present amounts previously reported in 2011, the effect of the change due to the retrospective adoption of the standard, and the adjusted amounts that are reflected in AIG's consolidated financial statements.

December 31, 2011 (in millions)	As Previously Reported		Effect of Change			As Currently Reported



Balance Sheet:
Current and deferred income taxes	$	16,084	$	1,718		$	17,802
Deferred policy acquisition costs		14,026		(5,089	)		8,937
Other assets		12,824		(42	)		12,782

Total assets		555,773		(3,413	)		552,360

Retained earnings		14,332		(3,558	)		10,774
Accumulated other comprehensive income		5,008		145			5,153

Total AIG shareholders' equity		104,951		(3,413	)		101,538

Three Months Ended March 31, 2011 (dollars in millions, except per share data)	As Previously Reported			Effect of Change			As Currently Reported



Statement of Operations:
Total net realized capital losses	$	(651	)	$	3		$	(648	)

Total revenues		17,436			3			17,439

Interest credited to policyholder account balances		1,105			1			1,106
Amortization of deferred acquisition costs		1,716			(485	)		1,231
Other acquisition and other insurance expenses		1,551			417			1,968

Total benefits, claims and expenses		18,816			(67	)		18,749

Income (loss) from continuing operations before income tax benefit		(1,380	)		70			(1,310	)

Income tax benefit^(a)		(200	)		(26	)		(226	)

Income (loss) from continuing operations		(1,180	)		96			(1,084	)
Income (loss) from discontinued operations, net of income tax expense^(b)		1,653			932			2,585

Net income		473			1,028			1,501

Net income attributable to AIG		269			1,028			1,297

Net income (loss) attributable to AIG common shareholders		(543	)		1,028			485

Income (loss) per share attributable to AIG common shareholders:
Basic:
Income (loss) from continuing operations	$	(1.41	)	$	0.07		$	(1.34	)
Income from discontinued operations	$	1.06		$	0.59		$	1.65
Diluted
Income (loss) from continuing operations	$	(1.41	)	$	0.07		$	(1.34	)
Income from discontinued operations	$	1.06		$	0.59		$	1.65

Adoption of the standard did not affect the previously reported totals for net cash flows provided by (used in) operating, investing, or financing activities, but did affect the following components of net cash flows provided by (used in) operating activities.

Three Months Ended March 31, 2011 (in millions)	As Previously Reported			Effect of Change			As Currently Reported



Cash flows from operating activities:
Net income	$	473		$	1,028		$	1,501
Income from discontinued operations		(1,653	)		(932	)		(2,585	)

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Noncash revenues, expenses, gains and losses included in income (loss):
Unrealized gains in earnings – net		(2,136	)		(3	)		(2,139	)
Depreciation and other amortization		2,336			(484	)		1,852
Changes in operating assets and liabilities:
Capitalization of deferred policy acquisition costs		(1,754	)		417			(1,337	)
Current and deferred income taxes – net		(585	)		(26	)		(611	)
Total adjustments		(5,362	)		(96	)		(5,458	)

For short-duration insurance contracts, starting in 2012, AIG has elected to include anticipated investment income in its determination of whether the deferred policy acquisition costs are recoverable. AIG believes the inclusion of anticipated investment income in the recoverability analysis is a preferable accounting policy, as it includes in the recoverability analysis the fact that there is a timing difference between when the premiums are collected and in turn invested and when the losses and related expenses are paid. This is considered a change in accounting principle that requires retrospective application to all periods presented. Because AIG historically has not recorded any premium deficiency on its short-duration insurance contracts even without the inclusion of anticipated investment income, there were no changes to the historical financial statements for the change in accounting principle.

In April 2011, the FASB issued an accounting standard that amends the criteria used to determine effective control for repurchase agreements and other similar arrangements such as securities lending transactions. The standard modifies the criteria for determining when these transactions would be accounted for as secured borrowings (i.e., financings) instead of sales of the securities.

The standard removes from the assessment of effective control the requirement that the transferor have the ability to repurchase or redeem the financial assets on substantially agreed terms, even in the event of default by the transferee. The removal of this requirement makes the level of collateral received by the transferor in a repurchase agreement or similar arrangement irrelevant in determining whether the transaction should be accounted for as a sale. Consequently, more repurchase agreements, securities lending transactions and similar arrangements will be accounted for as secured borrowings.

The guidance in the standard must be applied prospectively to transactions or modifications of existing transactions that occur on or after January 1, 2012. Under this standard, $1.2 billion in repurchase agreements (related to securities with a fair value of $1.8 billion) continued to be accounted for as sales as of March 31, 2012. Any modifications to these transactions that occur subsequent to adoption will result in an assessment of whether they should be accounted for as secured borrowings under the standard.

Common Fair Value Measurements and Disclosure Requirements in GAAP and IFRS

In May 2011, the FASB issued an accounting standard that amended certain aspects of the fair value measurement guidance in GAAP, primarily to achieve the FASB's objective of a converged definition of fair value and substantially converged measurement and disclosure guidance with International Financial Reporting Standards (IFRS). The measurement and disclosure requirements under GAAP and IFRS are now generally consistent, with certain exceptions including the accounting for day one gains and losses, measuring the fair value of alternative investments using net asset value and certain disclosure requirements.

The standard's fair value measurement and disclosure guidance applies to all companies that measure assets, liabilities, or instruments classified in shareholders' equity at fair value or provide fair value disclosures for items not recorded at fair value. While many of the amendments are not expected to significantly affect current practice, the guidance clarifies how a principal market is determined, addresses the fair value measurement of financial instruments with offsetting market or counterparty credit risks and the concept of valuation premise (i.e., in use or in exchange) and highest and best use, extends the prohibition on blockage factors to all three levels of the fair value hierarchy, and requires additional disclosures. The standard is effective for AIG for interim and annual periods beginning on January 1, 2012. The new disclosure requirements must be applied prospectively. The standard did not have any effect on AIG's consolidated financial condition, results of operations or cash flows. See Note 4 herein.

In June 2011, the FASB issued an accounting standard that requires the presentation of comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components, followed consecutively by a second statement that presents total other comprehensive income and its components. The standard did not have any effect on AIG's consolidated financial condition, results of operations or cash flows.

In September 2011, the FASB issued an accounting standard that amends the approach to testing goodwill for impairment. The standard simplifies how entities test goodwill for impairment by permitting an entity to first assess qualitative factors to determine whether it is more likely than not the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the quantitative, two-step goodwill impairment test. The standard is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The adoption of the standard did not affect AIG's consolidated financial condition, results of operations or cash flows.