2007 Annual Report - AIG.com

American International Group, Inc. and Subsidiaries
7. Variable Interest Entities
Continued
syndicated over $7 billion in partnership equity since 1991 to
other investors who will receive, among other benefits, tax credits
under certain sections of the Internal Revenue Code. AIG
Retirement Services, Inc. functions as the general partner in
certain investment partnerships and acts both as a credit
enhancer in certain transactions, through differing structures with
respect to funding development costs for the operating partnerships,
and as guarantor that investors will receive the tax benefits
projected at the time of syndication. AIG Retirement Services, Inc.
consolidates these investment partnerships as a result of the
guarantee provided to the investors. As part of their incentive
compensation, certain key SAAHP employees have been awarded
residual cash flow interests in the partnerships, subject to certain
vesting requirements. The operating income of SAAHP is reported,
along with other SunAmerica partnership income, as a component
of AIG’s Asset Management segment.
Insurance Investments
As part of its investment activities, AIG’s insurance operations
invest in obligations which include debt and equity securities and
interests issued by VIEs. These investments include investments
in AIG sponsored and non-sponsored investment funds, hedge
funds, private equity funds, and structured financing arrange-
ments. The investments in these VIEs allow AIG’s insurance
entities to purchase assets permitted by insurance regulations
while maximizing their return on these assets. AIG’s insurance
operations typically are not involved in the design or establish-
ment of the VIE, nor do they actively participate in the manage-
ment of the VIE.
In addition to changes in a VIE’s governing documentation or
capitalization structure, AIG reconsiders its position as to whether
it is the primary beneficiary as the result of investments in these
VIEs when AIG purchases or sells VIE issued debt and equity
interests to other unrelated parties.
AIGFP
The variable interests that AIGFP may hold in VIEs include debt
securities, equity interests, loans, derivative instruments and
other credit support arrangements. Transactions associated with
VIEs include an asset-backed commercial paper conduit, asset
securitizations, collateralized debt obligations, investment vehicles
and other structured financial transactions. AIGFP engages in
these transactions to facilitate client needs for investment
purposes and to obtain funding.
AIGFP invests in preferred securities issued by VIEs. Additionally,
AIGFP establishes VIEs that issue preferred interests to third
parties and uses the proceeds to provide financing to AIGFP
subsidiaries. In certain instances, AIGFP consolidates these VIEs.
Consistent with FIN 46R requirements, AIGFP reviews any changes
in its holdings of a VIEs preferred stock investment as part of its
reconsideration review to determine a VIE’s primary beneficiary. In
addition, AIG reviews all changes in such VIEs’ governing documentation
or capitalization structures as part of the determination of
whether there is a change in the VIEs’ primary beneficiaries.
AIGFP is the primary beneficiary of an asset-backed commercial
paper conduit with which it entered into several total return swaps
covering all the conduit’s assets that absorb the majority of the
expected losses of the entity. The assets of the conduit serve as
collateral for the conduit’s obligations. AIGFP is also the primary
beneficiary of several structured financing transactions in which
AIGFP holds the first loss position either by investing in the equity
of the VIE or implicitly through a lending or derivative arrangement.
These VIEs are subject to the reconsideration event reviews noted
above.
In certain instances, AIGFP enters into liquidity facilities with
various SPEs when AIGFP provides liquidity to the SPE in the form
of a guarantee, derivative, or a letter of credit and does not
consolidate the VIE. AIGFP also executes various swap and option
transactions with VIEs. Such contractual arrangements are done in
the ordinary course of business. Typically, interest rate derivatives
such as interest rate swaps and options executed with VIEs are
not deemed to be variable interests or significant variable
interests because the underlying is an observable market interest
rate and AIGFP as the derivative counterparty to the VIE is senior
to the debt and equity holders.
In 2007, AIGFP sponsored its only structured investment
vehicle (SIV) which invests in variable rate, investment-grade debt
securities. The SIV is a VIE because is does not have sufficient
equity to operate without subordinated capital notes which serve
as equity though they are legally debt instruments. The capital
notes absorb losses prior to the senior debt. Based on the sale of
more than 88 percent of its capital notes to unrelated third-party
investors and the continued holding by those investors of their
capital notes, AIGFP is not the primary beneficiary of the SIV.
AIGFP reviews its primary beneficiary position when the governing
document or capital structure changes or the amount of senior or
capital note holdings change. Based on a change in the governing
documents under which AIGFP committed to provide short-term
funding to the SIV, as necessary, a quantitative analysis performed
under FIN 46R as of December 31, 2007 showed that
AIGFP is not the primary beneficiary. This outcome is a result of
the high credit quality of the assets and the fact that 85 percent
of credit losses, if any, would be shared by other capital note
holders. At December 31, 2007 assets of this unconsolidated SIV
totaled $2.4 billion. AIGFP’s invested assets at December 31,
2007 included $1.7 billion of securities purchased under agree-
ments to resell and commercial paper and medium-term and
capital notes issued by this entity.
AIGFP has entered into transactions with VIEs that are used, in
part, to provide tax planning strategies to investors and/or AIGFP
through an enhanced yield investment security. These structures
typically provide financing to AIGFP and/or the investor at
enhanced rates. AIGFP may be either the primary beneficiary of
and consolidate the VIE, or may be a significant variable interest
holder in the VIE.
AIG 2007 Form 10-K 161