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ITEM 8 / NOTE 6. FAIR VALUE MEASUREMENTS.....................................................................................................................................................................................rates, and determinations on adjusting the participation rate and the cap on equity-indexed credited rates in light ofmarket conditions and policyholder behavior assumptions. These methodologies incorporate an explicit risk margin totake into consideration market participant estimates of projected cash flows and policyholder behavior.We also incorporate our own risk of non-performance in the valuation of the embedded policy derivatives associatedwith variable annuity and equity-indexed annuity and life contracts. Historically, the expected cash flows werediscounted using the interest rate swap curve (swap curve), which is commonly viewed as being consistent with thecredit spreads for highly-rated financial institutions (S&P AA-rated or above). A swap curve shows the fixed-rate legof a non-complex swap against the floating rate (for example, LIBOR) leg of a related tenor. The swap curve wasadjusted, as necessary, for anomalies between the swap curve and the U.S. Treasury yield curve. During the fourthquarter of 2010, we revised the non-performance risk adjustment to reflect a market participant’s view of AIG Lifeand Retirement’s claims paying ability. As a result, in 2010, we incorporated an additional spread to the swap curveused to value embedded policy derivatives, thereby reducing the fair value of the embedded derivative liabilities by$336 million, which was partially offset by $173 million of DAC amortization.Super Senior Credit Default Swap Portfolio..............................................................................................................................................................................................We value CDS transactions written on the super senior risk layers of designated pools of debt securities or loansusing internal valuation models, third-party price estimates and market indices. The principal market was determinedto be the market in which super senior credit default swaps of this type and size would be transacted, or have beentransacted, with the greatest volume or level of activity. We have determined that the principal market participants,therefore, would consist of other large financial institutions who participate in sophisticated over-the-counterderivatives markets. The specific valuation methodologies vary based on the nature of the referenced obligations andavailability of market prices.The valuation of the super senior credit derivatives is challenging given the limitation on the availability of marketobservable information due to the lack of trading and price transparency in certain structured finance markets. Thesemarket conditions have increased the reliance on management estimates and judgments in arriving at an estimate offair value for financial reporting purposes. Further, disparities in the valuation methodologies employed by marketparticipants and the varying judgments reached by such participants when assessing volatile markets have increasedthe likelihood that the various parties to these instruments may arrive at significantly different estimates as to theirfair values.Our valuation methodologies for the super senior credit default swap portfolio have evolved over time in response tomarket conditions and the availability of market observable information. We have sought to calibrate themethodologies to available market information and to review the assumptions of the methodologies on a regularbasis.Regulatory capital portfolio: In the case of credit default swaps written to facilitate regulatory capital relief, weestimate the fair value of these derivatives by considering observable market transactions. The transactions with themost observability are the early terminations of these transactions by counterparties. We continue to reassess theexpected maturity of the portfolio. There has been no requirement to make any payments as part of terminations ofsuper senior regulatory capital CDSs initiated by counterparties. In assessing the fair value of the regulatory capitalCDS transactions, we also consider other market data, to the extent relevant and available.Multi-sector CDO portfolios: We use a modified version of the Binomial Expansion Technique (BET) model tovalue our credit default swap portfolio written on super senior tranches of multi-sector CDOs of ABS. The BET modelwas developed in 1996 by a major rating agency to generate expected loss estimates for CDO tranches and derive acredit rating for those tranches, and remains widely used.We have adapted the BET model to estimate the price of the super senior risk layer or tranche of the CDO. Wemodified the BET model to imply default probabilities from market prices for the underlying securities and not fromrating agency assumptions. To generate the estimate, the model uses the price estimates for the securitiescomprising the portfolio of a CDO as an input and converts those estimates to credit spreads over current LIBORbasedinterest rates. These credit spreads are used to determine implied probabilities of default and expected losses..................................................................................................................................................................................................................................AIG 2012 Form 10-K 237
ITEM 8 / NOTE 6. FAIR VALUE MEASUREMENTS.....................................................................................................................................................................................on the underlying securities. This data is then aggregated and used to estimate the expected cash flows of the supersenior tranche of the CDO.Prices for the individual securities held by a CDO are obtained in most cases from the CDO collateral managers, tothe extent available. CDO collateral managers provided market prices for 59 percent of the underlying securities usedin the valuation at December 31, 2012. When a price for an individual security is not provided by a CDO collateralmanager, we derive the price through a pricing matrix using prices from CDO collateral managers for similarsecurities. Matrix pricing is a mathematical technique used principally to value debt securities without relyingexclusively on quoted prices for the specific securities, but rather by relying on the relationship of the security toother benchmark quoted securities. Substantially all of the CDO collateral managers who provided prices used dealerprices for all or part of the underlying securities, in some cases supplemented by third-party pricing services.The BET model also uses diversity scores, weighted average lives, recovery rates and discount rates. We employ aMonte Carlo simulation to assist in quantifying the effect on the valuation of the CDO of the unique aspects of theCDO’s structure such as triggers that divert cash flows to the most senior part of the capital structure. The MonteCarlo simulation is used to determine whether an underlying security defaults in a given simulation scenario and, if itdoes, the security’s implied random default time and expected loss. This information is used to project cash flowstreams and to determine the expected losses of the portfolio.In addition to calculating an estimate of the fair value of the super senior CDO security referenced in the creditdefault swaps using our internal model, we also consider the price estimates for the super senior CDO securitiesprovided by third parties, including counterparties to these transactions, to validate the results of the model and todetermine the best available estimate of fair value. In determining the fair value of the super senior CDO securityreferenced in the credit default swaps, we use a consistent process that considers all available pricing data pointsand eliminates the use of outlying data points. When pricing data points are within a reasonable range an averagingtechnique is applied.Corporate debt/Collateralized loan obligation (CLO) portfolios: In the case of credit default swaps written onportfolios of investment-grade corporate debt, we use a mathematical model that produces results that are closelyaligned with prices received from third parties. This methodology uses the current market credit spreads of thenames in the portfolios along with the base correlations implied by the current market prices of comparable tranchesof the relevant market traded credit indices as inputs.We estimate the fair value of our obligations resulting from credit default swaps written on CLOs to be equivalent tothe par value less the current market value of the referenced obligation. Accordingly, the value is determined byobtaining third-party quotations on the underlying super senior tranches referenced under the credit default swapcontract.Policyholder Contract Deposits..............................................................................................................................................................................................Policyholder contract deposits accounted for at fair value are measured using an earnings approach by taking intoconsideration the following factors:• Current policyholder account values and related surrender charges;• The present value of estimated future cash inflows (policy fees) and outflows (benefits and maintenance expenses)associated with the product using risk neutral valuations, incorporating expectations about policyholder behavior,market returns and other factors; and• A risk margin that market participants would require for a market return and the uncertainty inherent in the modelinputs.The change in fair value of these policyholder contract deposits is recorded as Policyholder benefits and claimsincurred in the Consolidated Statement of Operations...................................................................................................................................................................................................................................238 AIG 2012 Form 10-K
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American International Group, Inc.2
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KEY FACTS & FIGURES52,000+ $65.7 bi
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■We said we would return to profi
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Financial HighlightsYears Ended Dec
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~63,000AIG EMPLOYEES AROUND THE WOR
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$115.1 millionAVERAGE CLAIMS PAID E
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$10,000MAXIMUM DONATION MADE BY AIG
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American International Group, Inc.F
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AMERICAN INTERNATIONAL GROUP, INC.A
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ITEM 1 / BUSINESS / AIG............
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ITEM 1 / BUSINESS / AIG............
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ITEM 1 / BUSINESS / AIG PROPERTY CA
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ITEM 1 / BUSINESS / AIG PROPERTY CA
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ITEM 1 / BUSINESS / AIG LIFE AND RE
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ITEM 1 / BUSINESS / OTHER OPERATION
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ITEM 1 / BUSINESS / OTHER OPERATION
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ITEM 1 / BUSINESS..................
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ITEM 1 / BUSINESS..................
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ITEM 1 / BUSINESS..................
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ITEM 1 / BUSINESS..................
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ITEM 1 / BUSINESS..................
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ITEM 1A / RISK FACTORS.............
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ITEM 1B / UNRESOLVED STAFF COMMENTS
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ITEM 5 / MARKET FOR REGISTRANT’S
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ITEM 6 / SELECTED FINANCIAL DATA...
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ITEM 6 / SELECTED FINANCIAL DATA...
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ITEM 7 / MANAGEMENT’S DISCUSSION
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ITEM 7 / USE OF NON-GAAP MEASURES..
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ITEM 7 / EXECUTIVE SUMMARY.........
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ITEM 7 / RESULTS OF OPERATIONS.....
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ITEM 7 / LIQUIDITY AND CAPITAL RESO
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ITEM 7 / INVESTMENTS...............
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ITEM 7 / ENTERPRISE RISK MANAGEMENT
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ITEM 7 / CRITICAL ACCOUNTING ESTIMA
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Page 217 and 218: ITEM 7A / QUANTITATIVE AND QUALITAT
Page 219 and 220: ITEM 8 / INDEX TO FINANCIAL STATEME
Page 221 and 222: AMERICAN INTERNATIONAL GROUP, INC.C
Page 227 and 228: ITEM 8 / NOTE 1. BASIS OF PRESENTAT
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ITEM 8 / NOTE 15. DEBT OUTSTANDING.
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ITEM 8 / NOTE 15. DEBT OUTSTANDING.
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ITEM 8 / NOTE 16. CONTINGENCIES, CO
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ITEM 8 / NOTE 17. TOTAL EQUITY.....
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ITEM 8 / NOTE 18. NONCONTROLLING IN
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ITEM 8 / NOTE 19. EARNINGS (LOSS) P
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ITEM 8 / NOTE 20. STATUTORY FINANCI
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ITEM 8 / NOTE 21. SHARE-BASED COMPE
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ITEM 8 / NOTE 21. SHARE-BASED COMPE
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ITEM 8 / NOTE 22. EMPLOYEE BENEFITS
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ITEM 8 / NOTE 24. INCOME TAXES.....
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ITEM 8 / NOTE 26. QUARTERLY FINANCI
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ITEM 8 / NOTE 27. INFORMATION PROVI
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PART II............................
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PART IV............................
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SignatureTitle/s/ ARTHUR C. MARTINE
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ExhibitNumber Description Location(
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Condensed Financial Information of
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Condensed Financial Information of
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Notes to Condensed Financial Inform
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Supplementary Insurance Information
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Valuation and Qualifying AccountsFo
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Subsidiaries of RegistrantExhibit 2
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Percentageof VotingSecuritiesJurisd
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Percentageof VotingSecuritiesJurisd
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CONSENT OF INDEPENDENT REGISTERED P
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CERTIFICATIONSI, Robert H. Benmosch
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CERTIFICATIONExhibit 32In connectio
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SECURITIES REGISTERED PURSUANT TO S
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American International Group, Inc.1
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