REINSURANCE

6 Months Ended

Jun. 30, 2020

REINSURANCE

REINSURANCE

7. Reinsurance

In the ordinary course of business, our insurance companies may use both treaty and facultative reinsurance to minimize their net loss exposure to any single catastrophic loss event or to an accumulation of losses from a number of smaller events or to provide greater diversification of our businesses. In addition, our general insurance subsidiaries assume reinsurance from other insurance companies. We determine the portion of the incurred but not reported (IBNR) loss that will be recoverable under our reinsurance contracts by reference to the terms of the reinsurance protection purchased. This determination is necessarily based on the estimate of IBNR and accordingly, is subject to the same uncertainties as that estimate. Reinsurance assets include the balances due from reinsurance and insurance companies under the terms of our reinsurance agreements for paid and unpaid losses and loss adjustment expenses incurred, ceded unearned premiums and ceded future policy benefits for life and accident and health insurance contracts and benefits paid and unpaid. Amounts related to paid and unpaid losses and benefits and loss expenses with respect to these reinsurance agreements are substantially collateralized. We remain liable to the extent that our reinsurers do not meet their obligation under the reinsurance contracts, and as such, we regularly evaluate the financial condition of our reinsurers and monitor concentration of our credit risk. The estimation of the allowance for doubtful accounts requires judgment for which key inputs typically include historical trends regarding uncollectible balances, disputes and credit events as well as specific reviews of balances in dispute or subject to credit impairment.

Sale of Fortitude Holdings

On June 2, 2020, we completed the Majority Interest Fortitude Sale. AIG established Fortitude Re, a wholly owned subsidiary of Fortitude Holdings, in 2018 in a series of reinsurance transactions related to AIG’s Legacy Portfolio. As of June 30, 2020, approximately $30.5 billion of reserves from AIG’s Legacy Life and Retirement Run-Off Lines and approximately $4.1 billion of reserves from AIG’s Legacy General Insurance Run-Off Lines, related to business written by multiple wholly-owned AIG subsidiaries, had been ceded to Fortitude Re under these reinsurance transactions. As of closing of the Majority Interest Fortitude Sale, these reinsurance transactions are no longer considered affiliated transactions and Fortitude Re is the reinsurer of the majority of AIG’s Legacy Portfolio.

These reinsurance transactions between AIG and Fortitude Re were structured as modco and loss portfolio transfer arrangements with funds withheld (funds withheld). In modco and funds withheld arrangements, the investments supporting the reinsurance agreements, and which reflect the majority of the consideration that would be paid to the reinsurer for entering into the transaction, are withheld by, and therefore continue to reside on the balance sheet of, the ceding company (i.e., AIG) thereby creating an obligation for the ceding company to pay the reinsurer (i.e., Fortitude Re) at a later date. Additionally, as AIG maintains ownership of these investments, AIG will maintain its existing accounting for these assets (e.g., the changes in fair value of available for sale securities will be recognized within other comprehensive income). As a result of the deconsolidation resulting from the Majority Interest Fortitude Sale, AIG has established a funds withheld payable to Fortitude Re while simultaneously establishing a reinsurance asset representing reserves for the insurance coverage that Fortitude Re has assumed. The funds withheld payable contains an embedded derivative and changes in fair value of the embedded derivative related to the funds withheld payable are recognized in earnings through realized capital gains (losses). This embedded derivative is considered a total return swap with contractual returns that are attributable to various assets and liabilities associated with these reinsurance agreements.

There is a diverse pool of assets supporting the funds withheld arrangements with Fortitude Re. The following summarizes the composition of the pool of assets as of June 30, 2020:

June 30, 2020		Carrying		Fair
(in millions)		Value		Value	Corresponding Accounting Policy
Fixed maturity securities - available for sale(a)	$	35,380	$	35,380	Fair value through other comprehensive income
Fixed maturity securities - fair value option		190		190	Fair value through net investment income
Commercial mortgage loans		3,537		3,781	Amortized cost
Real estate investments		385		600	Amortized cost
Private equity funds / hedge funds		978		978	Fair value through net investment income
Policy loans		431		431	Amortized cost
Derivative assets, net(b)		-		-	Fair value through realized capital gains (losses)
Other		640		640	Amortized cost
Total	$	41,541	$	42,000

(a)The change in the net unrealized gains (losses) on available for sale securities related to the Fortitude Re funds withheld assets was $555 million ($438 million after-tax) during the post deconsolidation period (June 2, 2020-June 30, 2020).(b)The derivative assets have been presented net of collateral. The derivative assets supporting the Fortitude Re funds withheld arrangements had a fair market value of $650 million as of June 30, 2020. These derivative assets are fully collateralized.The impact of the funds withheld arrangements with Fortitude Re for the period post deconsolidation was as follows:

(in millions)
Net underwriting income	$	-
Net investment income - Fortitude Re funds withheld assets		116
Net realized capital losses on Fortitude Re funds withheld assets:
Net realized capital gains - Fortitude Re funds withheld assets		96
Net realized capital losses - Fortitude Re embedded derivatives		(837)
Net realized capital losses on Fortitude Re funds withheld assets		(741)
Loss from continuing operations before income tax benefit		(625)
Income tax benefit(a)		(131)
Net loss		(494)
Change in unrealized appreciation of all other investments(a)		438
Comprehensive loss	$	(56)

(a) The income tax expense (benefit) and the tax impact in accumulated other comprehensive income was computed using AIG’s U.S. statutory tax rate of 21 percent.

Various assets supporting the Fortitude Re funds withheld arrangements are reported at amortized cost, and as such, changes in the fair value of these assets are not reflected in the financial statements. However, changes in the fair value of these assets are included in the embedded derivative in the Fortitude Re funds withheld arrangements. During the period from June 2, 2020 to June 30, 2020, these assets appreciated by $56 million on a after-tax basis.

Reinsurance — Credit Losses

The estimation of reinsurance recoverables involves a significant amount of judgment, particularly for latent exposures, such as asbestos, due to their long-tail nature. Reinsurance assets include reinsurance recoverables on unpaid losses and loss adjustment expenses that are estimated as part of our loss reserving process and, consequently, are subject to similar judgments and uncertainties as the estimation of gross loss reserves. Similarly, Other assets include reinsurance recoverables for contracts which are accounted for as deposits.

We assess the collectability of reinsurance recoverable balances in each reporting period, through either historical trends of disputes and credit events or financial analysis of the credit quality of the reinsurer. We record adjustments to reflect the results of these assessments through an allowance for credit losses and disputes on uncollectable reinsurance that reduces the carrying amount of reinsurance and other assets on the consolidated balance sheets (collectively, the reinsurance recoverable balances). This estimate requires significant judgment for which key considerations include:

paid and unpaid amounts recoverable;whether the balance is in dispute or subject to legal collection;the relative financial health of the reinsurer as determined by the Obligor Risk Ratings (ORRs) we assign to each reinsurer based upon our financial reviews; insurers that are financially troubled (i.e., in run-off, have voluntarily or involuntarily been placed in receivership, are insolvent, are in the process of liquidation or otherwise subject to formal or informal regulatory restriction) are assigned ORRs that will generate a significant allowance; andwhether collateral and collateral arrangements exist.

An estimate of the reinsurance recoverable’s lifetime expected credit losses is established utilizing a probability of default and loss given default method, which reflects the reinsurer’s ORR rating. The allowance for credit losses excludes disputed amounts. An allowance for disputes is established for a reinsurance recoverable using the losses incurred model for contingencies.

The total reinsurance recoverables as of June 30, 2020 were $77.6 billion. As of that date, utilizing AIG’s ORRs, (i) approximately 87 percent of the reinsurance recoverables were investment grade, of which 82 percent related to General Insurance and 5 percent related to Life and Retirement; (ii) approximately 12 percent of the reinsurance recoverables were non-investment grade, the majority of which related to General Insurance; (iii) less than one percent of the non-investment grade reinsurance recoverables related to Life and Retirement and (iv) approximately one percent of the reinsurance recoverables related to entities that were not rated by AIG.

As of June 30, 2020, approximately 74 percent of our non-investment grade reinsurance exposure related to captive insurers. These arrangements are typically collateralized by letters of credit, funds held or trust agreements.

Reinsurance Recoverable Allowance

The following table presents a rollforward of the reinsurance recoverable allowance:

	Three Months Ended						Six Months Ended
	June 30, 2020						June 30, 2020
		General		Life and				General		Life and
(in millions)	Insurance		Retirement			Total	Insurance		Retirement			Total
Balance, beginning of period	$	302	$	60	$	362	$	111	$	40	$	151
Initial allowance upon CECL adoption		-		-		-		202		22		224
Current period provision for expected credit losses and disputes		6		1		7		2		3		5
Write-offs charged against the allowance for credit losses and
disputes		(2)		(1)		(3)		(5)		(5)		(10)
Other changes		(1)		(1)		(2)		(5)		(1)		(6)
Balance, end of period	$	305	$	59	$	364	$	305	$	59	$	364

There were no recoveries of credit losses previously written off for either of the three- and six-month periods ended June 30, 2020.

Past-Due Status

We consider a reinsurance asset to be past due when it is 90 days past due and record an allowance for disputes when there is reasonable uncertainty of the collectability of a disputed amount during the reporting period. Past due balances were not significant for any of the periods presented.