AIG 2011 Annual Report Download - page 154

The market price of fixed maturity securities reflects numerous components, including interest rate environment,
credit spread, embedded optionality (such as call features), liquidity, structural complexity, foreign exchange risk
and other credit and non-credit factors. However, in most circumstances, pricing is most sensitive to interest rates,
such that the market price declines as interest rates rise, and increases as interest rates fall. This effect is more
pronounced for longer duration securities.
AIG accounts for the vast majority of the invested assets held by its insurance companies at fair value.
However, with limited exceptions (primarily with respect to separate account products on AIG’s Consolidated
Balance Sheet), AIG does not modify the fair value of its insurance liabilities for changes in interest rates, even
though rising interest rates have the effect of reducing the fair value of such liabilities, and falling interest rates
have the opposite effect. This results in the recording of changes in unrealized gains (losses) on securities in
Accumulated other comprehensive income resulting from changes in interest rates without any correlative, inverse
changes in gains (losses) on AIG’s liabilities.
At December 31, 2011, approximately 88 percent of the fixed maturity securities were held by domestic entities.
Approximately 21 percent of such securities were rated AAA by one or more of the principal rating agencies.
Approximately 13 percent were below investment grade or not rated. AIG’s investment decision process relies
primarily on internally generated fundamental analysis and internal risk ratings. Third-party rating services’ ratings
and opinions provide one source of independent perspective for consideration in the internal analysis.
A significant portion of the foreign fixed maturity portfolio is rated by Moody’s, S&P or similar foreign rating
services. Rating services are not available in all overseas locations. AIG’s Credit Risk Management department
closely reviews the credit quality of the foreign portfolio’s non-rated fixed maturity securities. At December 31,
2011, approximately 26 percent of the foreign fixed maturity investments were either rated AAA or, on the basis
of AIG’s internal analysis, were equivalent from a credit standpoint to securities so rated. Approximately 3 percent
were below investment grade or not rated at that date. Approximately 51 percent of the foreign fixed maturity
portfolio are sovereign fixed maturity securities supporting policy liabilities in the country of issuance.
During 2011, significant volatility in the capital markets resulted in challenging conditions, both domestically and
globally. Ten-year U.S. Treasuries dropped to historic lows as rates were down 142 basis points, settling at
1.88 percent at the end of the year. Rates were mixed as Germany, France, and other perceived strong economies
followed the downward direction of U.S. rates, while countries such as Greece, Spain, and Italy saw a significant
increase in their borrowing costs due to rising concerns over their fiscal situations. Equity markets started the year
strongly, and were positive in the first half of the year before turning negative in the second half as the European
sovereign debt crisis intensified, catastrophe losses approached record levels, unemployment remained at elevated
levels, and a continued political standoff over measures addressing the U.S. deficit led to the first ever downgrade
of U.S. sovereign debt. Domestic equity markets were flat for the year, outperforming their foreign counterparts.
The performance in equity markets for 2011 stood in contrast to 2010, during which most markets recorded
positive returns. The swing from positive to negative equity market performance, combined with capital markets
volatility and a historically low interest rate environment in the U.S., resulted in lower net investment income in
2011 compared to 2010.
An overview of investment activities during 2011 is provided below:
Asset Composition
• Insurance operations purchased approximately $92 billion of fixed maturity securities. The purchases were
made using proceeds from sales and maturity of securities, paydowns on structured securities, cash flow from
operations and investments, and from the redeployment of existing cash and short-term investments.
Short-term investments were redeployed into approximately $23 billion of higher yielding fixed maturity
securities during 2011.
• Corporate debt (primarily high grade) represented approximately half of new purchases. Risk-weighted
opportunistic investments in structured securities continued to be made to improve yields and increase net
140 AIG 2011 Form 10-K
INVESTMENT HIGHLIGHTS