Exhibit 99.1

 

Table of Contents

 

American Life Insurance Company and the Transferred Subsidiaries

 

Index to the Combined Financial Statements

 

 

To the Shareholder and Management of American Life Insurance Company and the Transferred Subsidiaries:

 

In our opinion, the accompanying combined balance sheet and the related combined statements of income, of equity and of cash flows present fairly, in all material respects, the financial position of American Life Insurance Company, ALICO Services, Inc. and Delaware American Life Insurance Company and their subsidiaries (collectively, the “Company” or “American Life Insurance Company and the Transferred Subsidiaries”) at November 30, 2009, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

As described in Note 2 to the combined financial statements, the Company changed the manner in which it accounts for other-than-temporary impairments of fixed maturity securities as of March 1, 2009.

 

 

New York, New York

May 14, 2010

American Life Insurance Company and the Transferred Subsidiaries

 

Combined Balance Sheet

(In millions)

 

 

(See Note 16 for details of related party balances)

 

See accompanying notes to these combined financial statements.

American Life Insurance Company and the Transferred Subsidiaries

 

Combined Statement of Income

(In millions)

 

 

(See Note 16 for details of income and expenses from related parties.)

 

See accompanying notes to these combined financial statements.

American Life Insurance Company and the Transferred Subsidiaries

 

Combined Statement of Equity

(In millions)

 

 

 

 

See accompanying notes to these combined financial statements.

 

American Life Insurance Company and the Transferred Subsidiaries

 

Combined Statement of Cash Flows — (Continued)

 

(In millions)

 

 

See accompanying notes to these combined financial statements.

American Life Insurance Company and the Transferred Subsidiaries

 

Index of Notes to the Combined Financial Statements

 

American Life Insurance Company and the Transferred Subsidiaries

 

Notes to Combined Financial Statements

Year Ended November 30, 2009

 

 

These combined financial statements comprise the financial position and operating results of the managed insurance businesses of American Life Insurance Company (“ALICO”), ALICO Services, Inc. (formerly AIA Bermuda Services, Inc. or “ASI”) and Delaware American Life Insurance Company (“DELAM”), along with their consolidated subsidiaries (hereinafter referred to as “the “Company” or “American Life Insurance Company and the Transferred Subsidiaries”). The fiscal year of ALICO and ASI ends November 30 and the fiscal year of DELAM ends December 31. For purposes of these combined financial statements and accompanying notes, all financial data as of and for the year ended November 30 includes the financial position and operating results of DELAM as of and for its fiscal year ending December 31. The effects to these combined financial statements and accompanying notes by including DELAM using its fiscal year are not material. Unless otherwise indicated, all references in these combined financial statements and accompanying notes represent the financial position and results of operations as of and for the fiscal year ended November 30, 2009.

 

ALICO is a stock life insurance company domiciled in the State of Delaware, and is an indirect wholly-owned subsidiary of American International Group, Inc. (“AIG” or the “Parent”). It is licensed to write or maintain existing business in over 50 foreign countries through both branch operations and subsidiaries and writes all of its business outside of the United States of America, with diversified operations in Europe, Latin America, the Caribbean, the Middle East, and Japan. American Life Insurance Company markets traditional whole life, term, annuities, group life, credit life, and accident and health insurance to individuals and groups through a variety of distribution channels. DELAM is a stock life insurance company domiciled in the State of Delaware and is a wholly-owned subsidiary of AIG. It is licensed to write and reinsure life, annuity and accident and health business in the District of Columbia and 45 states in the United States of America. ASI is an indirect wholly-owned subsidiary of AIG, which provides services for a block of life insurance policies that are managed by the Company and included in these combined financial statements.

 

The combined financial statements also include certain international life insurance businesses that have been managed by ALICO but were previously legally owned by AIG or other AIG subsidiaries. These businesses were sold to or contributed to ALICO at fair value in 2009. These transactions have been accounted for as reorganizations of entities under common control and the combined financial statements presented have been adjusted so as to reflect the Company’s financial position and results of operations as if the purchased and contributed businesses were always a part of the Company. Consolidated subsidiaries include those entities in which the Company has a controlling financial interest, either through a majority voting interest or as the primary beneficiary of a variable interest entity. (See Note 7 for further information on the Company’s consolidated variable interest entities.)

 

Effective November 30, 2009, in connection with an AIG restructuring plan, AIG contributed all of the outstanding common shares of ALICO to a special purpose vehicle, ALICO Holdings, LLC (“ALICO Holdings”) in exchange for all common and preferred membership interests in ALICO Holdings. Additionally, AIG transferred the preferred membership interests in ALICO Holdings to the Federal Reserve Bank of New York (“FRBNY”) in satisfaction of $9 billion in outstanding obligations under the FRBNY’s credit facility provided to AIG. AIG holds all outstanding common interests of ALICO Holdings.

 

On March 7, 2010 AIG and ALICO Holdings entered into a definitive agreement for the sale of the Company to MetLife, Inc. (“MetLife”) for approximately $15.5 billion, including $6.8 billion in cash and the remainder in equity securities of MetLife, subject to closing adjustments. The cash portion of the proceeds from this sale will be used to reduce the liquidation preference of a portion of the preferred membership interests held by the FRBNY in ALICO Holdings. The transaction is expected to close in 2010 and is subject to certain regulatory approvals and other customary closing conditions.

 

American Life Insurance Company and the Transferred Subsidiaries

 

Notes to Combined Financial Statements — (Continued)

 

The Company’s combined financial statements have been prepared on the basis of accounting principles generally accepted in the United States of America (GAAP). All significant intercompany accounts and transactions have been eliminated.

 

 

Use of Estimates

 

The preparation of combined financial statements in conformity with GAAP requires Management to make estimates and assumptions that affect the reported amounts of certain assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.

 

The Company considers its most critical accounting estimates to be those with respect to items considered by Management in:

 

 

These accounting estimates require the use of assumptions about matters, some of which are highly uncertain at the time of estimation. To the extent actual experience differs from the assumptions used, the Company’s consolidated financial condition, results of operations and cash flows would be materially affected.

 

Accounting Policies

 

 

Premium income and other considerations:  Premiums for traditional life insurance products, life contingent annuities, and accident and health products are recognized as revenues when due. Estimates for premiums due but not yet collected are accrued. For limited pay insurance contracts where premiums are due over a significantly shorter period than the period over which benefits are provided, any excess profit is deferred and recognized into operations in a constant relationship to insurance in-force or, for annuities, the amount of expected future benefit payments.

 

Consideration for universal life and investment-type products is credited to policyholder account balances. Revenues for these contracts consist of policy charges for the cost of insurance, administration, and surrenders during the period. Policy charges collected with respect to future services are deferred and recognized in premium and other considerations in a manner similar to the amortization of deferred acquisition charges related to such products, which is described in section 2(j).

 

Net investment income:  Net investment income represents income primarily from the following sources:

 

 

American Life Insurance Company and the Transferred Subsidiaries

 

Notes to Combined Financial Statements — (Continued)

 

 

 

Net realized capital losses:  Net realized capital gains and losses are determined by specific identification. Realized capital gains and losses are generated primarily from the following sources:

 

 

Policyholder benefits and claims incurred:  Benefits for insurance contracts consist of benefits paid and changes in future policy benefit liabilities. Benefits for general account investment-type products, including separate accounts that do not qualify for separate account reporting under GAAP, primarily consist of interest credited to policy account balances and benefit payments made in excess of policy account balances except for certain contracts for which the fair value option was elected, for which benefits represent the entire change in fair value, including derivative gains and losses on related economic hedges.

 

Policy acquisition and other expenses:  Policy acquisition costs represent those costs associated with acquiring new business. Policy acquisition costs that vary with and are primarily related to the acquisition of new business, including commissions, premium taxes, and other underwriting expenses are deferred and amortized in relation to premium, estimated gross profits or gross margins. Those policy acquisition costs that do not vary with or are not primarily related to the acquisition of new business and other costs associated with the servicing and administration of existing business are expensed as incurred. Other expenses include insurance and non-insurance related expenses related to corporate services such as computer and communications costs, corporate stewardship services and other company-wide services. Certain of these services are provided by the Company’s parent, AIG, with the costs of these services either directly charged or allocated to the Company, using methods that Management believes are reasonable. (See Note 16, Related Parties.)

 

(b) Income taxes:  For periods prior to the AIG restructuring (See Note 1), the Company was included in the consolidated federal income tax return of AIG and subject to a tax-sharing arrangement that allocated tax on a separate return basis, but provided benefit for current utilization of losses and credits (a “benefits for loss” approach). Pursuant to the tax sharing agreement between the Company and AIG, the Company was paid for its tax attributes to the extent the Company could utilize such attributes on a separate return basis or such attributes could be utilized by other group members in the AIG consolidated life-nonlife U.S. income tax return.

 

Deferred tax assets and liabilities are recorded for the effects of temporary differences between the tax basis of an asset or liability and its reported amount in the combined financial statements and are measured using enacted tax rates in the applicable tax jurisdiction that are expected to apply to taxable income in the years the temporary differences are expected to reverse. The realization of deferred tax assets depends upon the existence of sufficient

 

American Life Insurance Company and the Transferred Subsidiaries

 

Notes to Combined Financial Statements — (Continued)

 

taxable income within the carryback or carryforward periods under the tax law in the applicable tax jurisdiction. The Company assesses its ability to realize deferred tax assets considering all available evidence, including the earnings history, the timing, character, and amount of future earnings potential, the reversal of temporary differences, and the tax planning strategies available when recognizing deferred tax assets. (See Note 17 herein for a further discussion of income taxes.)

 

The Company recognizes a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. The Company accounts for uncertain tax positions by determining whether it is more likely than not that a tax position will be sustained upon examination by the appropriate taxing authorities before any part of the benefit is recorded in the financial statements. A tax position is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon settlement. The Company may be required to change its provision for income taxes when the ultimate deductibility or taxability of certain items is challenged by taxing authorities. Additionally, future events, such as changes in tax laws or regulations or interpretations of such laws or regulations could have an impact on the provision for income taxes. Any such changes could significantly affect the amounts reported in the combined financial statements in the year these changes occur.

 

Interest and penalties related to unrecognized tax benefits are recognized in income tax expense.

 

(c) Investments in fixed maturity and equity securities:  Bonds, common stocks and preferred stocks are either classified as available for sale or as trading and are carried at fair value.

 

Securities held to meet long-term investment objectives are accounted for as available for sale, carried at fair value, and recorded on a trade-date basis. Realized gains and losses from available for sale investments in equity and fixed maturity securities are reflected in Net realized capital losses. Unrealized gains and losses are reported as a separate component of Accumulated other comprehensive income (loss), net of deferred income taxes, in the Combined Statement of Equity.

 

Premiums and discounts arising from the purchase of bonds classified as available for sale are treated as yield adjustments over their estimated lives, until maturity or call date, as applicable.

 

Trading securities are held primarily to meet certain policyholder liabilities where investment performance is borne by the policyholder. Trading securities are recorded on a trade-date basis and carried at fair value. Realized and unrealized gains and losses from investments in trading securities are reported in Net investment income.

 

(d) Mortgage and other loans receivable — net:  Mortgage and other loans receivable includes mortgage loans on real estate, and collateral, commercial and guaranteed loans. Mortgage loans on real estate and collateral, commercial and guaranteed loans are carried at unpaid principal balances less credit allowances, adjusted for any unamortized discount or premium, and deferred fees or expenses. Interest income on such loans is accrued as earned, based on the loan’s effective interest rate.

 

Impairment of mortgage and other loans receivable is evaluated based on certain risk factors and recognized when collection of all amounts due under the contractual terms is not probable. This impairment is generally measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate subject to the fair value of underlying collateral. Interest income on such impaired loans is recognized as cash is received.

 

As of November 30, 2009, the Company held less than 1% of its mortgage and other loans receivable portfolio in residential loans and over 99% in commercial mortgages and loan pools. Valuation allowances of $10 million and $47 million were applied to residential mortgage and to commercial mortgage holdings, respectively, as of November 30, 2009.

 

(e) Policy loans: Policy loans are carried at unpaid principal amount. There is no allowance for policy loans because these loans serve to reduce the death benefit paid when the death claim is made and the balances are effectively collateralized by the cash surrender value of the policies.

 

American Life Insurance Company and the Transferred Subsidiaries

 

Notes to Combined Financial Statements — (Continued)

 

(f) Short-term investments:  Short-term investments consist of interest-bearing cash equivalents, time deposits, and investments with original maturities of one year or less, such as commercial paper.

 

(g) Other invested assets:  Other invested assets consist primarily of investments in partially owned companies, investments in real estate, partnerships, hedge funds and freestanding derivatives.

 

Investments in partially owned companies:  Investments in partially owned companies are those made for strategic purposes and not solely for capital appreciation or for income generation. These investments are accounted for under the equity method. The carrying value of these investments was $45 million as of November 30, 2009 and the Company’s share of the investees’ net income was $9 million for the year ended November 30, 2009. Dividends received from unconsolidated entities were $0.5 million for the year ended November 30, 2009.

 

Investments in hedge funds and partnerships:  With respect to hedge funds and limited partnerships in which the Company holds a 5% or greater interest or less than a 5% interest but in which the Company has more than a minor influence over the operations of the investee, the Company accounts for these investments using the equity method. The carrying value is its share of the net asset value of the funds or the partnerships. The equity income or loss is recorded in Net investment income. In applying the equity method of accounting, the Company consistently uses the most recently available financial information provided by the general partner or manager of each of these investments, which is one to three months prior to the end of the Company’s reporting period.

 

Other investments of less than 5% in hedge funds and limited partnerships are reported at fair value. The change in fair value is recognized as a component of Accumulated other comprehensive income (loss).

 

Freestanding Derivatives:  Interest rate, currency, equity and credit default swaps, inflation-linked swaps, equity futures, options, and forward transactions are accounted for as derivatives recorded on a trade-date basis and carried at fair value. Unrealized gains and losses are reflected in income unless the derivative is designated as an effective cash flow or net investment hedge. Aggregate asset or liability positions are netted on the Combined Balance Sheet to the extent permitted by qualifying master netting arrangements in place with each respective counterparty. Cash collateral posted by the Company with counterparties in conjunction with these transactions is reported as a reduction of the corresponding net derivative liability. Cash collateral received by the Company in conjunction with these transactions is reported as a reduction of the corresponding net derivative asset.

 

(See Note 3 for additional disclosure regarding fair value methodologies.)

 

(h) Cash:  Cash represents cash on hand and non-interest bearing demand deposits.

 

(i) Premiums due and other insurance balances receivable-net:  Premiums due and other insurance balances receivable consist of premium balances, other receivables due from agents and brokers, reinsurance balances receivable and funds held reinsurance treaties. The allowance for doubtful accounts on premiums due and insurance balances receivable was $5 million as of November 30, 2009.

 

Reinsurance balances receivable reflect the balances due from reinsurance and insurance companies under the terms of the Company’s reinsurance agreements for paid and unpaid losses and loss expenses, ceded unearned premiums and ceded future policy benefits for life and accident and health insurance contracts and benefits paid and unpaid. The allowance for doubtful accounts on reinsurance balances receivable was $4 million as of November 30, 2009.

 

(j) Deferred policy acquisition costs (DAC):  Policy acquisition costs represent those costs, including commissions, premium taxes, and other underwriting expenses that vary with and are primarily related to the acquisition of new business.

 

Policy acquisition costs for participating life, traditional life and accident and health insurance products are generally deferred and amortized, with interest, over the premium paying period. Policy acquisition costs and policy issuance costs related to universal life and investment-type products are deferred and amortized, with interest, in

 

American Life Insurance Company and the Transferred Subsidiaries

 

Notes to Combined Financial Statements — (Continued)

 

relation to the incidence of estimated gross profits to be realized over the estimated lives of the contracts. Estimated gross profits are composed of net interest income, net realized investment gains and losses, fees, surrender charges, expenses, and mortality and morbidity gains and losses. If estimated gross profits change significantly, DAC is recalculated using the new assumptions. Any resulting adjustment is included in income as an adjustment to DAC. DAC is grouped consistent with the manner in which the insurance contracts are acquired, serviced, and measured for profitability and is reviewed for recoverability based on the current and projected future profitability of the underlying insurance contracts.

 

The DAC for universal life and investment type products is also adjusted with respect to estimated gross profits as a result of changes in the net unrealized gains or losses on fixed maturity and equity securities available for sale. Because fixed maturity and equity securities available for sale are carried at aggregate fair value, an adjustment is made to DAC equal to the change in amortization that would have been recorded if such securities had been sold at their stated aggregate fair value and the proceeds reinvested at current yields. The change in this adjustment, net of tax, is included with the change in net unrealized gains/losses on fixed maturity and equity securities available for sale that is credited or charged directly to Accumulated other comprehensive income (loss).

 

For contracts accounted for at fair value, policy acquisition costs are expensed as incurred and not deferred or amortized.

 

(k) Other assets:  Other assets primarily consist of company-occupied real estate and other fixed assets, goodwill, receivables from affiliates, prepaid expenses, including deposits, sales inducement assets, other deferred charges, and intangible assets other than goodwill.

 

Company occupied real estate and other fixed assets:  The costs of buildings, leasehold improvements, and furniture and equipment are depreciated principally on the straight-line basis over their estimated useful lives (maximum of 40 years for buildings, the term of the related leases, not to exceed 7 years, for leasehold improvements and 10 years for furniture and equipment). Expenditures for maintenance and repairs are charged to income as incurred; expenditures for betterment are capitalized and depreciated. The Company periodically assesses the carrying value of its real estate for purposes of determining any asset impairment.

 

Real estate and other fixed assets also include capitalized software costs, which represent costs of obtaining, developing, or upgrading internal use software. Such costs are capitalized and amortized using the straight-line method over a period generally not exceeding five years. The cost basis of computer software was $207 million as of November 30, 2009. Accumulated amortization of capitalized software was $88 million as of November 30, 2009 and related amortization expense was $26 million for the year ended November 30, 2009.

 

Real estate, fixed assets, and other long-lived assets are assessed for impairment when certain impairment indicators exist. Accumulated depreciation on company-occupied real estate and other fixed assets was $325 million as of November 30, 2009, and related depreciation expense was $42 million for the year ended November 30, 2009. The Company incurred an impairment charge of $13 million on fixed assets for the year ended November 30, 2009.

 

Goodwill:  Goodwill is the excess of the cost of an acquired business over the fair value of the identifiable net assets of the acquired business. Goodwill is tested for impairment annually, or more frequently if circumstances indicate that an impairment may have occurred. No goodwill impairments were recorded in 2009.

 

Sales inducement assets (SIA):  The Company offers sales inducements, which include enhanced crediting rates or bonus payments to contract holders (bonus interest) on certain annuity and investment contract products. Sales inducements provided to the contractholder are recognized as part of Policyholders’ contract deposits in the Combined Balance Sheet. Amortization expense is recognized in Policyholder benefits and claims. Such amounts are deferred and amortized over the life of the contract using the same methodology and assumptions used to amortize DAC. To qualify for such accounting treatment, the bonus interest must be explicitly identified in the contract at inception, and the Company must demonstrate that such amounts are incremental to amounts the

 

American Life Insurance Company and the Transferred Subsidiaries

 

Notes to Combined Financial Statements — (Continued)

 

Company credits on similar contracts without bonus interest, and are higher than the contracts’ expected ongoing crediting rates for periods after the bonus period. (See Note 6 herein for further discussion on sales inducements.)

 

(l) Future policy benefits for life and accident and health insurance contracts:  The liabilities for future policy benefits are established using assumptions described in Note 9 herein. Future policy benefits for life contracts include provisions for future dividends to participating policyholders, accrued in accordance with all applicable regulatory or contractual provisions. Accident and health insurance contracts include provisions for future dividends to participating policyholders, accrued in accordance with all applicable regulatory or contractual provisions.

 

(m) Policyholder contract deposits:  The liabilities for policyholder contract deposits are established using assumptions described in Note 9 herein. Policyholder contract deposits also include the Company’s liabilities for (a) certain guarantee benefits, accounted for as embedded derivatives at fair value, and (b) certain contracts that the Company has elected to account for at fair value.

 

(n) Other policyholder funds:  Other policyholder funds include policy and contract claims, unearned revenue liabilities, premiums received in advance, policyholder dividends due and unpaid, and policyholder dividends left on deposit. The liability for policy and contract claims generally relates to incurred but not reported death and accident and health claims, as well as claims that have been reported but not yet settled. The liability for these claims is based on the Company’s estimated ultimate cost of settling all claims. The Company derives estimates for the development of incurred but not reported claims principally from actuarial analyses of historical patterns of claims and claims development for each line of business. The methods used to determine these estimates are continually reviewed and resulting adjustments and differences between estimates and payments for claims are recognized in Policyholder benefits and claims incurred in the period in which the estimates are changed or payments are made.

 

The unearned revenue liability relates to investment-type products and represents policy charges to be earned in future periods. The charges are deferred as unearned revenue and amortized using the product’s estimated gross profits and margins, similar to DAC. Such amortization is recorded as investment-type product policy fees. The Company accounts for the prepayment of premiums on its individual life, group life, and health contracts as premium received in advance and applies the cash received to premiums when due.

 

(o) Other liabilities:  Other liabilities include amounts accrued for the resolution of non-insurance claims that have either been asserted or are deemed probable of assertion if, in the opinion of Management, it is both probable that a liability has been incurred and the amount of the liability can be reasonably estimated. Accounts payable to outside parties for services rendered or products purchased and balances payable to affiliates for goods or services are examples of these non-insurance claims recorded in Other liabilities. Additionally, reserves for general insurance losses and unearned premiums have been recorded in Other liabilities since they are immaterial and a non-core business to the Company.

 

In many cases, it is not possible to determine whether a liability has been incurred or to estimate the ultimate or minimum amount of that liability until years after the contingency arises, in which case, no accrual is made until that time.

 

(p) Foreign currency:  Financial statement accounts, where partially expressed in foreign currencies, are translated into U.S. dollars. Functional currency assets and liabilities are translated into U.S. dollars generally using rates of exchange prevailing at the balance sheet date of each respective subsidiary and the related translation adjustments are recorded as a separate component of Accumulated other comprehensive income (loss), net of any related taxes, in the Combined Statement of Equity. Functional currencies are generally the currencies of the local operating environment. The Combined Statement of Income accounts expressed in functional currencies are translated using average exchange rates during the period. The adjustments resulting from translation of financial statements of foreign entities operating in highly inflationary economies are recorded in Net realized capital gains

 

American Life Insurance Company and the Transferred Subsidiaries

 

Notes to Combined Financial Statements — (Continued)

 

and losses. Exchange gains and losses resulting from remeasuring foreign currency transactions into functional currencies are recorded in income as a component of Net realized capital gains and losses.

 

(q) Recent accounting standards:

 

Accounting Changes

 

The Company adopted the following accounting standards during 2009:

 

Amendment to Impairment Guidance

 

In January 2009, the Financial Accounting Standards Board (“FASB”) issued an accounting standard that amends the impairment guidance on recognition of interest income and impairment on purchased beneficial interests and beneficial interests that continue to be held by a transferor in securitized financial assets to achieve more consistent determination of whether an other-than-temporary impairment has occurred. The standard also retains and emphasizes the objective of an other-than-temporary impairment assessment and the related disclosure requirements. The effects of the standard on the Company’s combined financial condition and results of operations were not material.

 

Non-controlling interests in financial statements

 

In December 2007, the FASB issued an accounting standard that requires non-controlling (i.e., minority) interests in partially owned consolidated subsidiaries to be classified in the Balance Sheet as a separate component of equity, or in the mezzanine section of the Balance Sheet (between liabilities and equity) if such interests do not qualify for “permanent equity” classification. The new standard also specifies the accounting treatment for subsequent acquisitions and sales of non-controlling interests and how non-controlling interests should be presented in the Statement of Income (Loss). The non-controlling interests’ share of subsidiary income (loss) should be reported as a part of net income (loss) with disclosure of the attribution of net income (loss) to the controlling and non-controlling interests on the face of the Statement of Income (Loss).

 

Subsequent Events

 

In May 2009, the FASB issued an accounting standard that requires disclosure of the date through which a company evaluated the need to disclose events that occurred subsequent to the balance sheet date and whether that date represents the date the financial statements were issued or were available to be issued. The Company adopted the new standard and considers events through the date at which AIG issues its financial statements. The adoption of the new standard did not affect the Company’s financial condition, results of operations or cash flows.

 

Recognition and Presentation of Other-Than-Temporary Impairments

 

In April 2009, the FASB issued an accounting standard that requires a company to recognize the credit component of an other-than-temporary impairment of a fixed maturity security in earnings and the non-credit component in accumulated other comprehensive income when the company does not intend to sell the security and it is more likely than not that the company will not be required to sell the security prior to recovery. The standard also changed the threshold for determining when an other-than-temporary impairment has occurred on a fixed maturity security with respect to intent and ability to hold until recovery. The standard does not change the recognition of other-than-temporary impairment for equity securities. The standard requires additional disclosures in interim and annual reporting periods for fixed maturity and equity securities. (See Note 4, Investments, for the expanded disclosures.)

 

The Company adopted the new standard on March 1, 2009 and recorded an after-tax cumulative effect adjustment as of March 1, 2009 consisting of an increase in Shareholder’s net investment of $1 billion and a

 

American Life Insurance Company and the Transferred Subsidiaries

 

Notes to Combined Financial Statements — (Continued)

 

decrease to Accumulated other comprehensive income (loss) of $1 billion, net of tax. The cumulative effect adjustment resulted in an increase of approximately $1.6 billion in the amortized cost of fixed maturity securities, which has the effect of significantly reducing the accretion of investment income over the remaining life of the underlying securities, beginning in the second quarter of 2009. The effect of the reduced investment income will be offset, in part, by a decrease in the amortization of DAC and SIA.

 

The new standard is expected to reduce the level of other-than-temporary impairment charges recorded in earnings for fixed maturity securities due to the following required changes in the Company’s accounting policy for other-than-temporary impairments (see Note 4 for a more detailed discussion of the changes in policy):

 

 

The following table presents the components of the change in equity as of March 1, 2009 due to the adoption of the new accounting standard for other-than-temporary impairments:

 

 

Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly

 

In April 2009, the FASB issued an accounting standard that provides guidance for estimating the fair value of assets and liabilities when the volume and level of activity for an asset or liability have significantly decreased and for identifying circumstances that indicate a transaction is not orderly. The new standard also requires extensive additional fair value disclosures. The adoption of the new standard on March 1, 2009 did not have a material effect on the Company’s financial condition, results of operations or cash flows.

 

Measuring Liabilities at Fair Value

 

In August 2009, the FASB issued an accounting standard to clarify how the fair value measurement principles should be applied to measuring liabilities carried at fair value. The new standard explains how to prioritize market inputs in measuring liabilities at fair value and what adjustments to market inputs are appropriate for debt obligations that are restricted from being transferred to another obligor. The new standard was effective beginning September 1, 2009 for the Company. The adoption of the new standard did not have a material effect on the Company’s financial condition, results of operations or cash flows.

 

American Life Insurance Company and the Transferred Subsidiaries

 

Notes to Combined Financial Statements — (Continued)

 

Investments in Certain Entities that Calculate Net Asset Value per Share (or Its Equivalent)

 

In September 2009, the FASB issued an accounting standard update that permits, as a practical expedient, a company to measure the fair value of an investment that is within the scope of the update on the basis of the net asset value per share of the investment (or its equivalent) if that value is calculated in accordance with fair value as defined by the FASB. The standard also requires enhanced disclosures. The update applies to investment companies that do not have readily determinable fair values such as certain hedge funds and private equity funds. The adoption of the accounting standard update did not have a material effect on the Company’s combined financial condition, results of operations, or cash flows.

 

 

Fair Value Measurements on a Recurring Basis

 

The Company measures at fair value on a recurring basis financial instruments in its trading and available for sale securities portfolios, derivative assets and liabilities, securities lending invested collateral, non-traded equity investments, certain private limited partnerships, and certain hedge funds included in Other invested assets, certain short-term investments, separate and variable account assets and certain policyholder contract deposits. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between willing, able and knowledgeable market participants at the measurement date.

 

The degree of judgment used in measuring the fair value of financial instruments generally correlates with the level of pricing observability. Financial instruments with quoted prices in active markets generally have more pricing observability and less judgment is used in measuring fair value. Conversely, financial instruments traded in other-than-active markets or that do not have quoted prices have less observability and are measured at fair value using valuation models or other pricing techniques that require more judgment. An active market is one in which transactions for the asset or liability being valued occur with sufficient frequency and volume to provide pricing information on an ongoing basis. An other-than-active market is one in which there are few transactions, the prices are not current, price quotations vary substantially either over time or among market makers, or in which little information is released publicly for the asset or liability being valued. Pricing observability is affected by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established, the characteristics specific to the transaction and general market conditions.

 

Fair Value Hierarchy

 

Assets and liabilities recorded at fair value in the Combined Balance Sheet are measured and classified in a hierarchy for disclosure purposes consisting of three “levels” based on the observability of inputs available in the marketplace as discussed below:

 

 

American Life Insurance Company and the Transferred Subsidiaries

 

Notes to Combined Financial Statements — (Continued)

 

 

 

Valuation Methodologies

 

The following is a description of the valuation methodologies used for instruments carried at fair value on a recurring basis:

 

Incorporation of Credit Risk in Fair Value Measurements

 

A key component to the fair value measurement is the incorporation of nonperformance risk, including credit risk. The credit risk of the counterparty is incorporated into the calculation of the credit risk adjustment for fair value measurements in an asset position. Fair values for fixed maturity securities based on observable market prices for identical or similar instruments implicitly incorporate counterparty credit risk. The Company’s own credit risk is incorporated into the calculation of the credit risk adjustment for fair value measurements in a liability position. The Company also uses the assumptions that a market participant would use in pricing the asset or liability. This includes a market participant’s assumptions about the risk of default and how that risk will be valued.

 

Generally, the current credit exposure of the Company’s derivative contracts is limited to the net positive estimated fair value of derivative contracts at the reporting date after taking into consideration the existence of netting agreements and any collateral received. The Company manages its credit risk related to over-the-counter derivatives by entering into transactions with creditworthy counterparties.

 

Fixed Maturity Securities — Trading and Available for Sale

 

The Company maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. Whenever available, the Company obtains quoted prices in active markets for identical assets at the balance sheet date to measure at fair value fixed maturity securities in its trading and available for sale portfolios. Market price data generally is obtained from dealer markets.

 

The Company estimates the fair value of fixed maturity securities not traded in active markets by referring to traded securities with similar attributes, using dealer quotations, a matrix pricing methodology, discounted cash flow analyses and/or internal valuation models. This methodology considers such factors as the issuer’s industry, the security’s rating and tenor, its coupon rate, its position in the capital structure of the issuer, yield curves, credit curves, prepayment rates and other relevant factors. For certain fixed maturity instruments (for example, private placements) that are not traded in active markets or that are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments generally are based on available market evidence. In the absence of such evidence, Management’s best estimate is used.

 

American Life Insurance Company and the Transferred Subsidiaries

 

Notes to Combined Financial Statements — (Continued)

 

Equity Securities Traded in Active Markets — Trading and Available for Sale

 

The Company maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. Whenever available, the Company obtains quoted prices in active markets for identical assets at the balance sheet date to measure at fair value marketable equity securities in its trading and available for sale portfolios. Market price data generally is obtained from exchange or dealer markets.

 

Hedge Funds, Private Equity Funds and Other Investment Partnerships — Other Invested Assets

 

The Company initially estimates the fair value of investments in certain hedge funds, private equity funds and other investment partnerships by reference to the transaction price. Subsequently, the Company generally obtains the fair value of these investments from net asset value information provided by the general partner or manager of the investments, the financial statements of which are generally audited annually. The Company considers observable market data and performs diligence procedures in validating the appropriateness of using the net asset value as a fair value measurement.

 

Separate Account Assets

 

Separate account assets are composed primarily of registered and unregistered open-end mutual funds that generally trade daily and are measured at fair value in the manner discussed above for equity securities traded in active markets.

 

Freestanding Derivatives

 

Derivative assets and liabilities can be exchange-traded or traded over-the-counter (OTC). The Company generally values exchange-traded derivatives using quoted prices in active markets for identical derivatives at the balance sheet date.

 

OTC derivatives are valued using market transactions and other market evidence whenever possible, including market-based inputs to models, model calibration to market clearing transactions, broker or dealer quotations or alternative pricing sources with reasonable levels of price transparency. When models are used, the selection of a particular model to value an OTC derivative depends on the contractual terms of, and specific risks inherent in the instrument, as well as the availability of pricing information in the market. The Company generally uses similar models to value similar instruments. Valuation models require a variety of inputs, including contractual terms, market prices and rates, yield curves, credit curves, measures of volatility, prepayment rates and correlations of such inputs. For OTC derivatives that trade in liquid markets, such as generic forwards, swaps and options, model inputs can generally be corroborated by observable market data by correlation or other means, and model selection does not involve significant Management judgment.

 

Certain OTC derivatives trade in less liquid markets with limited pricing information, and the determination of fair value for these derivatives is inherently more difficult. When the Company does not have corroborating market evidence to support significant model inputs and cannot verify the model to market transactions, the transaction price is initially used as the best estimate of fair value. Accordingly, when a pricing model is used to value such an instrument, the model is adjusted so the model value at inception equals the transaction price. Subsequent to initial recognition, the Company updates valuation inputs when corroborated by evidence such as similar market transactions, third party pricing services and/or broker or dealer quotations, or other empirical market data. When appropriate, valuations are adjusted for various factors such as liquidity, bid/offer spreads and credit considerations. Such adjustments are generally based on available market evidence. In the absence of such evidence, Management’s best estimate is used.

 

American Life Insurance Company and the Transferred Subsidiaries

 

Notes to Combined Financial Statements — (Continued)

 

Embedded Derivatives

 

The Company purchases and issues financial instruments and products that contain embedded derivative instruments. When it is determined that (1) the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, and (2) a separate instrument with the same terms would qualify as a derivative instrument, the embedded derivative is bifurcated from the host for measurement purposes. The embedded derivative, which is reported with the host instrument in the Combined Balance Sheet, is carried at fair value with changes in fair value reported in net realized capital gains and losses or Policyholder benefits and claims incurred, as appropriate.

 

Policyholder Contract Deposits

 

Policyholder contract deposits accounted for at fair value are measured using an earnings approach by taking into consideration the following factors:

 

 

The change in fair value of these policyholder contract deposits, including any premiums or fees collected, is recorded as Policyholder benefits and claims incurred in the Combined Statement of Income. Policy fees and premiums collected are not recorded separately as revenue.

 

American Life Insurance Company and the Transferred Subsidiaries

 

Notes to Combined Financial Statements — (Continued)

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

The following table presents information about assets and liabilities measured at fair value on a recurring basis and indicates the level of the fair value measurement based on the levels of the inputs used:

 

 

 

 

American Life Insurance Company and the Transferred Subsidiaries

 

Notes to Combined Financial Statements — (Continued)

 

 

Changes in Level 3 recurring fair value measurements

 

The following table presents the changes during 2009 in Level 3 assets and liabilities measured at fair value on a recurring basis, and the realized and unrealized gains (losses) recorded in income during 2009 related to the Level 3 assets and liabilities that remained in the Combined Balance Sheet as of November 30, 2009:

 

 

American Life Insurance Company and the Transferred Subsidiaries

 

Notes to Combined Financial Statements — (Continued)

 

 

 

 

 

Both observable and unobservable inputs may be used to determine the fair values of positions classified in Level 3 in the tables above. As a result, the unrealized gains (losses) on instruments held as of November 30, 2009 may include changes in fair value that were attributable to both observable (e.g. changes in market interest rates) and unobservable inputs (e.g. changes in unobservable long-dated volatilities).

 

The Company’s policy is to transfer assets and liabilities into Level 3 when a significant input cannot be corroborated with market observable data. This may include: circumstances in which market activity has dramatically decreased and transparency to underlying inputs cannot be observed, current prices are not available, and substantial price variances in quotations among market participants exist.

 

In certain cases, the inputs used to measure the fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement. An assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment. In making the assessment, factors specific to the asset or liability are considered.

 

American Life Insurance Company and the Transferred Subsidiaries

 

Notes to Combined Financial Statements — (Continued)

 

Investments in certain entities carried at fair value using net asset value per share:

 

The following table includes information related to investments in certain other invested assets, including private equity funds, hedge funds and other alternative investments that calculate net asset value per share (or its equivalent). For these investments, which are measured at fair value on a recurring or non-recurring basis at November 30, 2009, the net asset value per share is used as a practical expedient for fair value:

 

 

 

 

Private equity fund investments included above are not redeemable during the lives of the funds, and have expected remaining lives that extend in some cases to 10 years. Ten percent of such funds have expected remaining lives of less than three years and ninety percent between 7 and 10 years. Expected lives are based upon legal maturity, which can be extended at the general manager’s discretion, typically in one year increments.

 

Global real estate fund investments included above are not redeemable during the lives of the funds, and have expected remaining lives that extend from 3 to 7 years.

 

Fair Value Measurements on a Non-Recurring Basis

 

The fair value of certain assets are measured on a non-recurring basis, generally quarterly, annually, or when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. These assets include cost and equity-method investments; collateral securing foreclosed loans and real estate and other fixed assets; and goodwill. A variety of techniques are used to measure the fair value of these assets when appropriate, as described below:

 

 

American Life Insurance Company and the Transferred Subsidiaries

 

Notes to Combined Financial Statements — (Continued)

 

companies, discounted expected future cash flows, appraisals, or, in the case of reporting units being considered for sale, third-party indications of fair value of the reporting unit, if available, to determine the amount of any impairment.

 

 

See Note 2 (d) and (k) herein for additional information about how various asset classes are tested for impairment.

 

Fair Value Option

 

Effective December 1, 2008, the Company elected to apply the fair value option to certain single premium variable life products in Japan classified within policyholder contract deposits in the Combined Balance Sheet. For the year ended November 30, 2009, the Company recorded a gain of $123 million in Policyholder benefits and claims incurred. The Company elected the fair value option for these liabilities to more closely align its accounting with the economics of its transactions. The fair value option election has allowed the Company to better match the inherent market risks associated with this business in an efficient and effective manner through the use of derivative instruments entered into with AIG. The accounting presentation for this business more closely reflects the underlying economics and the way the business is managed. In the third quarter of 2009, the Company unwound certain of these affiliated derivatives in conjunction with AIG’s restructuring and divestiture plans. A substantial portion of the inherent market risks associated with this business remains economically hedged as of November 30, 2009. (See Note 18, Subsequent Events.)

 

Fair Value Information about Financial Instruments Not Measured at Fair Value

 

Information regarding the estimation of fair value for financial instruments not carried at fair value (excluding insurance contracts and lease contracts) is discussed below:

 

 

American Life Insurance Company and the Transferred Subsidiaries

 

Notes to Combined Financial Statements — (Continued)

 

 

 

The following table presents the carrying value and estimated fair value of the Company’s financial instruments:

 

 

American Life Insurance Company and the Transferred Subsidiaries

 

Notes to Combined Financial Statements — (Continued)

 

 

(a)  Securities Available for Sale

 

The following table presents the amortized cost or cost and fair value of the Company’s available for sale securities:

 

 

 

 

American Life Insurance Company and the Transferred Subsidiaries

 

Notes to Combined Financial Statements — (Continued)

 

 

The following table summarizes the fair value and gross unrealized losses on available for sale securities, aggregated by major investment category and length of time that individual securities have been in a continuous unrealized loss position: