2007 Annual Report - AIG.com

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American International Group, Inc. and Subsidiaries Management’s Discussion and Analysis of Financial Condition and Results of Operations Continued The following table presents AIG’s largest credit exposures at December 31, 2007 as a percentage of total shareholders’ equity: Credit Exposure as a Percentage of Total Category Risk Rating (a) Shareholders’ Equity Investment Grade: 10 largest combined A+ (weighted 84.8% average) (b) Single largest non-sovereign (financial institution) AA– 8.4 Single largest corporate AAA 5.4 Single largest sovereign A 15.7 Non-Investment Grade: Single largest sovereign BB– 1.8 Single largest non-sovereign B+ 0.5 (a) Risk rating is based on external ratings, or equivalent, based on AIG’s internal risk rating process. (b) Six of the ten largest credit exposures are to highly-rated financial institutions and three are to investment-grade rated sovereigns; none is rated lower than BBB+ or its equivalent. AIG closely controls its aggregate cross-border exposures to senior tranches of CDOs. In addition, AIG Investments invests avoid excessive concentrations in any one country or regional directly in commercial real estate properties and provides real group of countries. AIG defines its cross-border exposure to estate commercial mortgage loans. include both cross-border credit exposures and its large cross- Some of AIG’s exposures are insured (‘‘wrapped’’) by financial border investments in its own international subsidiaries. Ten guarantor insurance companies, also known as ‘‘monoline insurcountries had cross-border exposures in excess of 10 percent of ers’’, which at December 31, 2007, provide AIG over $44 billion total shareholders’ equity; seven are AAA-rated and three are (carrying value) in financial support. The monoline insurers include AA-rated. MBIA, Ambac, FGIC, and others and provide support predomi- In addition, AIG closely monitors its industry concentrations, nantly in the United States. AIG does not rely on the monoline the risks of which are often mitigated by the breadth and scope of insurance as its principal source of repayment when evaluating AIG’s international operations. securities for purchase. All investment securities are evaluated ( AIG’s single largest industry credit exposure is to the highly- primarily based on the underlying cash flow generation capacities rated global financial institutions sector, accounting for 87 per- of the issuer or cash flow characteristics of the security. cent of total shareholders’ equity at December 31, 2007. Approximately 96 percent of the monoline protection is ( Excluding the U.S. residential and commercial mortgage sec- provided on AIG Investments’ fixed maturities exposures, of which tors, AIG’s other industry credit concentrations in excess of municipal securities represent 74 percent of assets insured, 10 percent of total shareholders’ equity at December 31, 2007 substantially all of which had underlying credit ratings of ‘‘A’’ or are to the following industries (in descending order by approxi- higher. AIG considers that the monoline wrap for such securities is mate size): of limited support, as the default rate on single A and higher – Electric and water utilities; rated municipal bonds has historically been negligible. However, – Oil and gas; AIG anticipates that the failure of one or more monoline insurers – European regional financial institutions; may cause price volatility and other disruption in the municipal – Global telecommunications companies; bond market, as market participants adjust to the absence of – Global life insurance carriers; monoline credit support. AIG maintains a credit staff to evaluate – U.S.-based regional financial institutions; its municipal bond holdings, and does not rely on monoline – Global securities firms and exchanges; and insurers in evaluating securities for its municipal bond portfolios. – Global reinsurance firms. Approximately four percent of AIG’s monoline insurance sup- AIG participates in the U.S. residential and commercial ports AIGFP investment exposures. mortgage markets through AGF, which originates principally first- For the non-municipal assets in the AIG Investments portfolio, lien mortgage loans and, to a lesser extent, second-lien mortgage at December 31, 2007, AIG owned $9.5 billion in cost basis or loans to buyers and owners of residential housing; UGC which $8.8 billion in fair value of various types of asset-backed provides first loss mortgage guaranty insurance for high loan-to- securities wrapped by one or more of the monoline insurers. value first- and second-lien residential mortgages; AIG Investments Based on internal analysis, approximately $6.7 billion in cost which invests in mortgage-backed securities and collateralized basis represented holdings with underlying ratings estimated at debt obligations, on behalf of AIG insurance and financial services BBB or higher. AIG has generally viewed the monoline credit subsidiaries, in which the underlying collateral comprises residen- support on these securities as significant only to ‘‘tail’’ risk, that tial or commercial mortgage loans; and AIGFP which invests in is, the risk that as pools of underlying assets amortize, the highly rated tranches of RMBS, CMBS and CDOs and provides remaining assets, or ‘‘tail’’, may suffer from adverse selection on credit protection through credit default swaps on certain super prepayments or from a lack of adequate risk diversification. While 114 AIG 2007 Form 10-K
American International Group, Inc. and Subsidiaries these securities initially had underlying investment grade ratings, capital. Similar to the income statement, AIG’s overall balance poor pool performance has in some cases resulted in current sheet is net long foreign currencies and net short U.S. dollars. ratings of below investment grade. The amount of ultimate loss exposure of these securities to the monoline insurers is a The table below provides an estimate of the sensitivity of function of the ultimate performance of the collateral pools and shareholders’ equity and net income to 10 percent changes in cannot be reliably estimated. AIG believes that monoline insurers the value of the U.S. dollar relative to foreign currencies as of are currently providing payment support on approximately December 31, 2007, assuming a tax rate of 35 percent: $380 million of such securities. U.S. dollar up U.S. dollar down The CRC reviews quarterly concentration reports in all catego- (in millions) 10 percent 10 percent ries listed above as well as credit trends by risk ratings. The CRC Shareholders’ equity $(466) $466 may adjust limits to provide reasonable assurance that AIG does Net income $(220) $220 not incur excessive levels of credit risk and that AIG’s credit risk profile is properly calibrated across business units. AIG analyzes market risk using various statistical techniques including Value at Risk (VaR). VaR is a summary statistical Market Risk Management measure that uses the estimated volatility and correlation of market factors to calculate the maximum loss that could occur AIG is exposed to market risks, primarily within its insurance and over a defined period of time with a specified level of statistical capital markets businesses. These asset-liability exposures are confidence. VaR measures not only the size of individual expopredominantly structural in nature, and not the result of specula- sures but also the interaction between different market expotive positioning to take advantage of short-term market opportuni- sures, thereby providing a portfolio approach to measuring market ties. The Market Risk Management department (MRM), which risk. Similar VaR methodologies are used to determine capital reports to the CRO, is responsible for control and oversight of requirements for market risk within AIG’s economic capital market risks in all aspects of AIG’s financial services, insurance, framework. and investment activities. AIG’s market exposures arise from the following: Insurance, Asset Management and Non-Trading Financial Services ( AIG is a globally diversified enterprise with capital deployed in a VaR variety of currencies. Capital deployed in AIG’s overseas AIG performs one comprehensive VaR analysis across all of its businesses, when converted into U.S. dollars for financial non-trading businesses, and a separate VaR analysis for its reporting purposes, constitutes a ‘‘long foreign currency/short trading business at AIGFP. The comprehensive VaR is categorized U.S. dollar’’ market exposure on AIG’s balance sheet. Similarly, by AIG business segment (General Insurance, Life Insurance & overseas earnings denominated in foreign currency also repre- Retirement Services, Financial Services and Asset Management) sent a ‘‘long foreign currency/short U.S. dollar’’ market and also by market risk factor (interest rate, currency and equity). exposure on AIG’s income statement. AIG’s market risk VaR calculations include exposures to bench- ( Much of AIG’s domestic capital is invested in U.S. fixed income mark Treasury or swap interest rates, but do not include or equity securities, leading to exposures to U.S. yields and exposures to credit-based factors such as credit spreads. AIG’s equity markets. credit exposures within its invested assets and credit derivative ( Several of AIG’s Foreign Life Insurance subsidiaries operate in portfolios are discussed in Credit Risk Management — Financial developing markets where maturities on longer-term life insur- Services herein. ance liabilities exceed the maximum maturities of available For the insurance segments, assets included are invested local currency assets. assets (excluding direct holdings of real estate) and liabilities As a globally diversified enterprise, AIG is exposed to a variety included are reserve for losses and loss expenses, reserve for of foreign currency risks. AIG earns a significant portion of its unearned premiums, future policy benefits for life and accident income from operations conducted in foreign currencies which and health insurance contracts and other policyholders’ funds. For must be translated into U.S. dollars for consolidated reporting financial services companies, loans and leases represent the purposes. Consequently, exchange rate fluctuations can cause majority of assets represented in the VaR calculation, while bonds volatility in AIG’s reported earnings. When the U.S. dollar weakens and notes issued represent the majority of liabilities. against other currencies, AIG’s earnings increase. When the AIG calculated the VaR with respect to net fair values as of U.S. dollar strengthens against other currencies, AIG’s earnings December 31, 2007 and 2006. The VaR number represents the decline. maximum potential loss as of those dates that could be incurred The sensitivity of AIG’s consolidated shareholders’ equity to with a 95 percent confidence (i.e., only five percent of historical foreign exchange volatility is more complex. AIG has significant scenarios show losses greater than the VaR figure) within a onecapital committed overseas, which rises in value on AIG’s month holding period. AIG uses the historical simulation methodolconsolidated balance sheet when the U.S. dollar weakens. AIG ogy that entails repricing all assets and liabilities under explicit also has significant U.S. dollar asset holdings overseas, which changes in market rates within a specific historical time period. offset the foreign exchange exposure arising from AIG’s overseas AIG uses the most recent three years of historical market information for interest rates, foreign exchange rates, and equity AIG 2007 Form 10-K 115
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AMERICAN INTERNATIONAL GROUP, INC.
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FINANCIAL HIGHLIGHTS (in millions,
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overall financial condition, althou
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Group Executive Committee We are ad
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AIG’s life insurance network is t
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We have also begun to address the e
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WHAT WE SEE The ability to see and
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The Major Accounts Practice within
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Around the world, the middle class
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WE SEE GROWTH OPPORTUNITIES IN EMER
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To grow the strength of the AIG glo
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Since 2003, the AIG Disaster Relief
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RESPECT Respect encompasses how we
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Life Insurance & Retirement Service
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Domestic Brokerage Group— Gross P
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In the summer of 2007, widespread f
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in gross premiums written. It launc
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It grew new business premiums from
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emerging markets for its services,
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ILFC—Revenues by Region Total = $
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AIG Investments acquired a 94 perce
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and changing interest rates, as wel
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American International Group, Inc.
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UNITED STATES SECURITIES AND EXCHAN
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SHAREHOLDER INFORMATION Corporate H
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