AIG 2005 Annual Report Download - page 118

Management’s Discussion and Analysis of
Financial Condition and Results of Operations Continued
segment. For the calculations in the analyses the financial each transaction was repriced. Portfolio, business unit and
instrument assets included are the insurance segments’ invested finally AIG-wide scenario values are then calculated by netting
assets, excluding real estate and investment income due and the values of all the underlying assets and liabilities.
accrued, and the financial instrument liabilities included are The following table presents the VaR on a combined basis and
reserve for losses and loss expenses, reserve for unearned of each component of market risk for each of AIG’s insurance
premiums, future policy benefits for life and accident and segments as of December 31, 2005 and 2004. Due to
health insurance contracts and other policyholders’ funds. diversification effects, the combined VaR is always smaller
AIG calculated the VaR with respect to the net fair value than the sum of its components.
of each of AIG’s insurance segments as of December 31, 2005
and December 31, 2004. The VaR number represents the Life Insurance &
maximum potential loss as of those dates that could be General Insurance Retirement Services
incurred with a 95 percent confidence (i.e., only five percent of (in millions) 2005 2004 2005 2004
historical scenarios show losses greater than the VaR figure) Market risk:
within a one-month holding period. AIG uses the historical Combined $1,617 $1,396 $4,515 $5,024
simulation methodology that entails repricing all assets and Interest rate 1,717 1,563 4,382 4,750
liabilities under explicit changes in market rates within a Currency 130 139 541 478
specific historical time period. AIG uses the most recent three Equity 535 727 762 1,024
years of historical market information for interest rates, foreign
exchange rates, and equity index prices. For each scenario,
The following table presents the average, high and low VaRs on a combined basis and of each component of market risk for
each of AIG’s insurance segments for the years 2005 and 2004. Due to diversification effects, the combined VaR is always
smaller than the sum of its components.
2005 2004
(in millions) Average High Low Average High Low
General Insurance:
Market risk:
Combined $1,585 $1,672 $1,396 $1,299 $1,497 $1,100
Interest rate 1,746 1,931 1,563 1,407 1,591 1,173
Currency 125 139 111 111 139 88
Equity 651 727 535 744 797 688
Life Insurance & Retirement Services:
Market risk:
Combined $4,737 $5,024 $4,515 $4,021 $5,024 $3,075
Interest rate 4,488 4,750 4,382 3,831 4,750 2,967
Currency 511 560 442 326 478 257
Equity 953 1,024 762 884 1,024 758
The Combined VaR and Interest Rate VaR for Life positions. Credit exposure is managed separately. See the
Insurance & Retirement Services trended higher during 2004 discussion on the management of credit risk above.
because of growth in the Asian life businesses. The December AIG’s Market Risk Management Department provides
2004 VaR results are equal to the maximum values observed detailed independent review of AIG’s market exposures,
during the year. particularly those market exposures of the Capital Markets
During 2005, the Combined VaR and Interest Rate VaR for operations. This department determines whether AIG’s market
Life Insurance & Retirement Services remained in a narrower risks, as well as those market risks of individual subsidiaries, are
range. The December 2005 VaR results are somewhat lower within the parameters established by AIG’s senior manage-
than the December 2004 figures because long-term interest ment. Well established market risk management techniques
rates in Asia declined during the year. such as sensitivity analysis are used. Additionally, this depart-
In addition, the increase in Combined and Interest Rate ment verifies that specific market risks of each of certain
VaRs from 2004 to 2005 in the General Insurance division was subsidiaries are managed and hedged by that subsidiary.
caused by growth in this business. ILFC is exposed to market risk and the risk of loss of fair
value and possible liquidity strain resulting from adverse
fluctuations in interest rates. As of December 31, 2005 and
Financial Services
December 31, 2004, AIG statistically measured the loss of fair
AIG generally manages its market exposures within Financial value through the application of a VaR model. In this analysis,
Services by maintaining offsetting positions. Capital Markets the net fair value of Aircraft Finance operations was deter-
seeks to minimize or set limits for open or uncovered market mined using the financial instrument assets which included the
66 AIG m Form 10-K