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

The liability for unpaid claims and claims adjustment expense 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 currently reflected 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.

The following table presents the reconciliation of activity in the Liability for unpaid claims and claims adjustment expense:




Years Ended December 31, (in millions)	2012			2011			2010

Liability for unpaid claims and claims adjustment expense, beginning of year	$	91,145		$	91,151		$	85,386
Reinsurance recoverable		(20,320	)		(19,644	)		(17,487	)

Net liability for unpaid claims and claims adjustment expense, beginning of year		70,825			71,507			67,899

Foreign exchange effect		757			353			(126	)
Acquisitions^(a)		–			–			1,538
Dispositions		(11	)		–			(87	)
Changes in net loss reserves due to NICO transaction		90			(1,703	)		–

Total		71,661			70,157			69,224

Losses and loss expenses incurred^(b):
Current year		25,385			27,931			24,455
Prior years, other than accretion of discount^(c)		421			195			4,182
Prior years, accretion of discount		(63	)		34			(562	)

Total		25,743			28,160			28,075

Losses and loss expenses paid^(b):
Current year		9,297			11,534			9,873
Prior years		19,325			15,958			15,919

Total		28,622			27,492			25,792

Balance, end of year:
Net liability for unpaid claims and claims adjustment expense		68,782			70,825			71,507
Reinsurance recoverable		19,209			20,320			19,644

Total	$	87,991		$	91,145		$	91,151

(a) Represents the acquisition of Fuji on March 31, 2010.

(b) Includes amounts related to dispositions through the date of disposition.

(c) In 2012, includes $262 million, $46 million and $326 million related to excess casualty, commercial specialty workers' compensation and environmental, respectively. In 2011, includes $(414) million, $145 million and $413 million related to excess casualty, commercial specialty workers' compensation and environmental, respectively. In 2010, includes $1.1 billion, $793 million and $1.5 billion related to excess casualty, excess workers' compensation and asbestos, respectively.

The net adverse development includes loss-sensitive business, for which we recognized a $54 million, $172 million and $8 million loss-sensitive premium adjustment for the years ended December 31, 2012, 2011 and 2010, respectively.

The 2010 net adverse loss development for prior accident years primarily relates to the asbestos, excess casualty, excess workers' compensation and primary workers' compensation. Further, this charge primarily relates to accident years 2007 and prior (accident years before the financial crisis in 2008) and a significant amount relates to accident 2005 and prior (accident years prior to the start of the managed reduction in these long-tail lines of business). In 2010, the reserve charges were primarily due to long-tail lines of business which have been reduced since 2006. In the case of asbestos, since 1985, standard policies have contained an absolute exclusion for asbestos and pollution-related damages. The factors driving excess casualty loss cost were primarily due to medical inflation and the exhaustion of underlying primary policies for products liability coverage and for homebuilders. In 2010, excess workers' compensation also experienced significant prior year development related to the passage of the Affordable Care Act in March 2010 as we concluded that there is increased vulnerability to the risk of further cost-shifting to the excess workers' compensation class of business.

Discounting of Reserves

At December 31, 2012, the liability for unpaid claims and claims adjustment expense reflects a net loss reserve discount of $3.2 billion, including tabular and non-tabular calculations based upon the following assumptions:

•: The tabular workers' compensation discount is calculated using a 3.5 percent interest rate and the 1979-81 Decennial Mortality Table.
•: The non-tabular workers' compensation discount is calculated separately for companies domiciled in New York and Pennsylvania, and follows the statutory regulations for each state. For New York companies, the discount is based on a five percent interest rate and the companies' own payout patterns. For Pennsylvania companies, the statute has specified discount factors for accident years 2001 and prior, which are based on a six percent interest rate and an industry payout pattern. For accident years 2002 and subsequent, the discount is based on the payout patterns and investment yields of the companies.
•: Certain asbestos business that was written by AIG Property Casualty 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 discount consists of the following: $801 million – tabular discount for workers' compensation in the domestic operations of AIG Property Casualty and $2.4 billion – non-tabular discount for workers' compensation in the domestic operations of AIG Property Casualty; and $51 million – non-tabular discount for asbestos for AIG Property Casualty.

Future Policy Benefits

Future policy benefits for life and accident and health insurance contracts include provisions for future dividends to participating policyholders, accrued in accordance with all applicable regulatory or contractual provisions. Also 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. Structured settlement liabilities are presented on a discounted basis because the settled claims are fixed and determinable. Policyholder contract deposits also include our liability for (a) certain guarantee benefits 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 elected to account for at fair value.

The following table presents the components of future policy benefits:




At December 31, (in millions)	2012		2011

Future policy benefits:
Long duration and contracts	$	36,121	$	33,322
Short duration contracts		219		995

Total future policy benefits	$	36,340	$	34,317

Long duration contract liabilities included in future policy benefits, as presented in the preceding table, result primarily from life products. Short duration contract liabilities are primarily accident and health products. The liability for future life policy benefits has been established on the basis of the following assumptions:

•: Interest rates (exclusive of immediate/terminal funding annuities), which vary by year of issuance and products, range from 1 percent to 9.5 percent within the first 20 years. Interest rates on immediate/terminal funding annuities are at a maximum of 13.5 percent and grade to not greater than zero percent.
•: Mortality and surrender rates are based upon actual experience modified to allow for variations in policy form. The weighted average lapse rate, including surrenders, for individual and group life was approximately 7.1 percent.
•: Participating life business represented approximately 2.0 percent of the gross insurance in force at December 31, 2012 and 4.2 percent of gross Premiums and other considerations in 2012. The amount of annual dividends to be paid is approved locally by the boards of directors of the life 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.

Policyholder Contract Deposits

The following table presents policyholder contract deposits liabilities:




At December 31, (in millions)	2012		2011

Policyholder contract deposits:
Annuities	$	98,544	$	98,657
Universal life products		13,045		12,917
Guaranteed investment contracts		6,178		6,788
Variable products – fixed account option		3,936		3,181
Corporate life products		2,284		2,239
Other investment contracts		3,130		3,116

Total policyholder contract deposits	$	127,117	$	126,898

The liability for policyholder contract deposits has been established based on the following assumptions:

•: Interest rates credited on deferred annuities, which vary by year of issuance, range from 1 percent to, including bonuses, 9 percent. Current declared interest rates are generally guaranteed to remain in effect for a period of one year though some are guaranteed for longer periods. Withdrawal charges generally range from zero percent to 20 percent grading to zero over a period of zero to 15 years.
•: Guaranteed investment contracts (GICs) have market value withdrawal provisions for any funds withdrawn other than benefit responsive payments. Interest rates credited generally range from 0.5 percent to 8.5 percent. The majority of these GICs mature within four years.
•: Interest rates on corporate life insurance products are guaranteed at 3 percent and the weighted average rate credited in 2012 was 4.6 percent.
•: The universal life products have credited interest rates of 1 percent to 8 percent and guarantees ranging from 1 percent to 5.5 percent depending on the year of issue. Additionally, universal life funds are subject to surrender charges that amount to 9.7 percent of the aggregate fund balance grading to zero over a period not longer than 20 years.
•: For variable products and investment contracts, policy values are expressed in terms of investment units. Each unit is linked to an asset portfolio. The value of a unit increases or decreases based on the value of the linked asset portfolio. The current liability at any time is the sum of the current unit value of all investment units plus any liability for guaranteed minimum death or withdrawal benefits.

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, and the unearned portions of the premiums recorded as liabilities. 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.