AIG 2011 Annual Report Download - page 190

AIGFP Derivative Transactions
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 CRM. Transactions that fall
outside these pre-established guidelines require the specific approval of the CRM. It is also AIG’s policy to record
credit valuation adjustments for potential counterparty default when necessary.
In addition, AIGFP utilizes various credit enhancements, including letters of credit, guarantees, collateral, credit
triggers, credit derivatives, margin agreements and subordination 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. Furthermore, 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 set off 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 fair values. The fair value of AIGFP’s
interest rate, currency, commodity and equity swaps, options, swaptions, and forward commitments, futures, and
forward contracts reported in Derivative assets, at fair value, was approximately $3.8 billion at December 31, 2011
and $4.8 billion at December 31, 2010. 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 CRM. In addition,
AIGFP’s credit approval process involves pre-set counterparty and country credit exposure limits subject to
approval by the CRM and, for particularly credit-intensive transactions, requires approval from the CRM.
The following table presents the fair value of AIGFP’s derivatives portfolios by counterparty credit rating:
At December 31,
(in millions) 2011 2010
Rating:
AAA $ 260 $ 310
AA 58 885
A1,156 1,170
BBB 2,081 1,625
Below investment grade 247 795
Total $ 3,802 $ 4,785
See Critical Accounting Estimates below and Note 12 to the Consolidated Financial Statements for additional
discussion related to derivative transactions.
AIGFP Trading VaR
AIGFP attempts to minimize risk in benchmark interest rates, equities, commodities and foreign exchange.
Market exposures in option-implied volatilities, correlations and basis risks are also managed over time.
AIGFP’s minimal reliance on market risk-driven revenue is reflected in its VaR. AIGFP’s VaR calculation is
based on the interest rate, equity, commodity and foreign exchange risk arising from its portfolio. Credit-related
factors, such as credit spreads or credit default, are not included in AIGFP’s VaR calculation. Because the
non-credit market risk with respect to securities available for sale, at market, is substantially hedged, segregation
of the financial instruments into trading and other than trading was not considered necessary. AIGFP operates
under established market risk limits based upon this VaR calculation. In addition, AIGFP back-tests its VaR.
176 AIG 2011 Form 10-K