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 AIG also monitors key international property risks utilizing actively monitors and controls its aggregate accumulated exposure modeled statistical return period losses. Based on these simula- within the parameters of the protection provided by the TRIA. tions, the 100-year return period loss for Japanese Earthquake is $510 million gross, and $170 million net, the 100-year return Life Insurance & Retirement Services period loss for European Windstorm is $448 million gross, and In Life Insurance & Retirement Services, the primary risks are the $154 million net, and the 100-year return period loss for following: Japanese Typhoon is $340 million gross, and $212 million net. ( underwriting, which represents the exposure to loss resulting The losses provided above do not include Transatlantic and from the actual policy experience emerging adversely in Ascot. The combined earthquake and tropical cyclone 100-year comparison to the assumptions made in the product pricing return period modeled losses for Ascot and Transatlantic together associated with mortality, morbidity, termination and expenses; are estimated to be $1.0 billion, on a gross basis, $749 million, and net of reinsurance. ( investment risk which represents the exposure to loss resulting ACTUAL RESULTS IN ANY PERIOD ARE LIKELY TO VARY, from the cash flows from the invested assets being less than PERHAPS MATERIALLY, FROM THE MODELED SCENARIOS, AND the cash flows required to meet the obligations of the expected THE OCCURRENCE OF ONE OR MORE SEVERE EVENTS COULD policy and contract liabilities and the necessary return on HAVE A MATERIAL ADVERSE EFFECT ON AIG’S FINANCIAL CONDI- investments. TION, RESULTS OF OPERATIONS AND LIQUIDITY. AIG businesses manage these risks through exposure limitations and the active management of the asset-liability relationship Measures Implemented to Control Hurricane and Earthquake in their operations. The emergence of significant adverse experi- Catastrophic Risk ence would require an adjustment to DAC and benefit reserves Catastrophic risk from the earthquake and hurricane perils is that could have a material adverse effect on AIG’s consolidated proactively managed through reinsurance programs, and aggregate results of operations for a particular period. accumulation monitoring. Catastrophe reinsurance is purchased by AIG’s Foreign Life Insurance & Retirement Services companies AIG from financially sound reinsurers. Recoveries under this generally limit their maximum underwriting exposure on life program, along with other non-catastrophic reinsurance protec- insurance of a single life to approximately $1.7 million of tions, are reflected in the net values provided in the tables above. coverage. AIG’s Domestic Life Insurance & Retirement Services In addition to catastrophic reinsurance programs, hurricane and companies limit their maximum underwriting exposure on life earthquake exposures are controlled by periodically monitoring insurance of a single life to $15 million of coverage in certain aggregate exposures. The aggregate exposures are calculated by circumstances by using yearly renewable term reinsurance. In Life compiling total liability within AIG defined hurricane and earth- Insurance & Retirement Services, the reinsurance programs quake catastrophe risk zones and therefore represent the maxi- provide risk mitigation per policy, per individual life for life and mum that could be lost in any individual zone. These aggregate group covers and for catastrophic risk events. accumulations are tracked over time in order to monitor both longand short-term trends. AIG’s major property writers, Lexington and Pandemic Influenza AIG Private Client Group, have also implemented catastrophe- The potential for a pandemic influenza outbreak has received related underwriting procedures and manage their books at an much recent attention. While outbreaks of the Avian Flu continue account level. Lexington individually models most accounts prior to to occur among poultry or wild birds in a number of countries in binding in order to specifically quantify catastrophic risk for each Asia, Europe, including the U.K., and Africa, transmission to account. humans has been rare to date. If the virus mutates to a form that Terrorism can be transmitted from human to human, it has the potential to spread rapidly worldwide. If such an outbreak were to take place, Exposure to loss from terrorist attack is controlled by limiting the early quarantine and vaccination could be critical to containment. aggregate accumulation of workers compensation and property The contagion and mortality rates of any mutated H5N1 virus insurance that is underwritten within defined target locations. that can be transmitted from human to human are highly Modeling is used to provide projections of probable maximum loss speculative. AIG continues to monitor the developing facts. A by target location based upon the actual exposures of AIG significant global outbreak could have a material adverse effect on policyholders. Life Insurance & Retirement Services operating results and Terrorism risk is monitored to manage AIG’s exposure. AIG liquidity from increased mortality and morbidity rates. AIG continshares its exposures to terrorism risks under the Terrorism Risk ues to analyze its exposure to this serious threat and has Insurance Act, which was recently extended through December 31, engaged an external risk management firm to model loss 2014 by the Terrorism Risk Insurance Program Reauthorization Act scenarios associated with an outbreak of Avian Flu. For a ‘‘mild’’ of 2007 (TRIA). During 2007, AIG’s deductible under TRIA was scenario, AIG estimates its after-tax net losses under its life approximately $4.0 billion, with a 15 percent share of certified insurance policies due to Avian Flu at approximately 2 percent of terrorism losses in excess of the deductible. As of January 1, consolidated shareholders’ equity as of December 31, 2007. This 2008, the deductible increased to $4.2 billion, with a 15 percent estimate was calculated over a 3-year period, although the share of certified terrorism losses in excess of the deductible. AIG 120 AIG 2007 Form 10-K
American International Group, Inc. and Subsidiaries In addition, AIGFP utilizes various credit enhancements, including letters of credit, guarantees, collateral, credit triggers, credit derivatives and margin agreements to reduce the credit risk relating to its outstanding financial derivative transactions. AIGFP requires credit enhancements in connection with specific transactions based on, among other things, the creditworthiness of the counterparties, and the transaction’s size and maturity. Further- more, AIGFP generally seeks to enter into agreements that have the benefit of set-off and close-out netting provisions. These provisions provide that, in the case of an early termination of a transaction, AIGFP can setoff its receivables from a counterparty against its payables to the same counterparty arising out of all covered transactions. As a result, where a legally enforceable netting agreement exists, the fair value of the transaction with the counterparty represents the net sum of estimated positive fair values. The fair value of AIGFP’s interest rate, currency, commodity and equity swaps, options, swaptions, and forward commitments, futures, and forward contracts approximated $17.13 billion at December 31, 2007 and $19.61 billion at December 31, 2006. Where applicable, these amounts have been determined in accordance with the respective master netting agreements. AIGFP evaluates the counterparty credit quality by reference to ratings from rating agencies or, where such ratings are not available, by internal analysis consistent with the risk rating policies of the CRC. In addition, AIGFP’s credit approval process involves pre-set counterparty and country credit exposure limits and, for particularly credit-intensive transactions, requires approval from the CRC. AIG estimates that the average credit rating of Capital Markets derivatives counterparties, measured by reference to the fair value of its derivative portfolio as a whole, is equivalent to the AA rating category. majority of the losses would be incurred in the first year. The modeled losses calculated were based on 2006 policy data representing approximately 92 percent of AIG’s individual life, group life and credit life books of business, net of reinsurance. This estimate does not include claims that could be made under other policies, such as business interruption or general liability policies, and does not reflect estimates for losses resulting from disruption of AIG’s own business operations or asset losses that may arise out of such a pandemic. The model used to generate this estimate has only recently been developed. The reasonableness of the model and its underlying assumptions cannot readily be verified by reference to comparable historical events. As a result, AIG’s actual losses from a pandemic influenza outbreak are likely to vary significantly from those predicted by the model. Financial Services AIG’s Financial Services subsidiaries engage in diversified activi- ties including aircraft and equipment leasing, capital markets, consumer finance and insurance premium finance. Capital Markets The Capital Markets operations of AIG are conducted primarily through AIGFP, which engages as principal in standard and customized interest rate, currency, equity, commodity, energy and credit products with top-tier corporations, financial institutions, governments, agencies, institutional investors and high-net-worth individuals throughout the world. The senior management of AIG defines the policies and establishes general operating parameters for Capital Markets operations. AIG’s senior management has established various oversight committees to monitor on an ongoing basis the various financial market, operational and credit risk attendant to the Capital Markets operations. The senior management of AIGFP At December 31, 2007 and 2006, the fair value of Capital Markets reports the results of its operations to and reviews future derivatives portfolios by counterparty credit rating was as follows: strategies with AIG’s senior management. AIGFP actively manages its exposures to limit potential economic (in millions) 2007 2006 losses, while maximizing the rewards afforded by these Rating: business opportunities even though some products or derivatives AAA $ 5,069 $ 5,465 may result in operating income volatility. In doing so, AIGFP must AA 5,166 8,321 continually manage a variety of exposures including credit, market, A 4,796 3,690 liquidity, operational and legal risks. BBB 1,801 2,032 Below investment grade 302 99 Derivative Transactions Total $17,134 $19,607 Credit Derivatives AIGFP enters into credit derivative transactions in the ordinary course of its business. The majority of AIGFP’s credit derivatives require AIGFP to provide credit protection on a designated portfolio of loans or debt securities. AIGFP provides such credit protection on a ‘‘second loss’’ basis, under which AIGFP’s payment obligations arise only after credit losses in the designated portfolio exceed a specified threshold amount or level of ‘‘first losses.’’ The threshold amount of credit losses that must be realized before AIGFP has any payment obligation is negotiated A counterparty may default on any obligation to AIG, including a derivative contract. Credit risk is a consequence of extending credit and/or carrying trading and investment positions. Credit risk exists for a derivative contract when that contract has a positive fair value to AIG. The maximum potential exposure will increase or decrease during the life of the derivative commitments as a function of maturity and market conditions. To help manage this risk, AIGFP’s credit department operates within the guidelines set by the CRC. Transactions which fall outside these pre-established guidelines require the specific approval of the CRC. It is also AIG’s policy to establish reserves for potential credit impairment when necessary. AIG 2007 Form 10-K 121
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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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Page 191 and 192: Index of Notes to Consolidated Fina
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SHAREHOLDER INFORMATION Corporate H
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