AIG 2011 Annual Report Download - page 198

AIG has a dynamic hedging program designed to manage economic risk exposure associated with changes in the
fair value of GMWB and GMAV liabilities caused by changes in the equity markets, interest rates and market
implied volatilities. The program utilizes hedging instruments, including derivatives such as equity options, futures
contracts and interest rate swap contracts, and is designed so that changes in value of the hedging instruments
move in the opposite direction of changes in the GMWB and GMAV embedded derivative liabilities. AIG
monitors daily, and rebalances as needed, the hedging positions in relation to the change in valuation of GMWB
and GMAV embedded derivative liabilities. However, differences between the change in fair value of GMWB and
GMAV embedded derivative liabilities and the hedging instruments can be caused by extreme and unanticipated
movements in the equity markets, interest rates and market volatility, policyholder behavior, statutory capital
considerations and constraints and the ability to purchase hedging instruments at prices consistent with the desired
risk and return trade-off. None of the derivative instruments described above are designated for hedge accounting.
Approximately 48 percent of AIG’s individual variable annuity account values contain either a GMWB rider or
a GMAV rider as of December 31, 2011. Declines in the equity markets, increased volatility and a sustained low
interest rate environment increase AIG’s exposure to potential benefits under the GMWB and GMAV contracts,
leading to an increase in the existing liability for those benefits. AIG’s exposure to the guaranteed amounts is
equal to the amount by which the contract holder’s account balance is below the guaranteed withdrawal or
account value amount. As of December 31, 2011, AIG’s exposure to the guaranteed withdrawal and account value
amount under GMWB and GMAV was $1.4 billion and $27 million, respectively. However, the only way the
GMWB contract holder can monetize the excess of the guaranteed amount over the account value of the contract
is through a series of withdrawals that do not exceed a specific percentage per year of the guaranteed amount. If,
after the series of withdrawals, the account value is exhausted, the contract holder will receive a series of annuity
payments equal to the remaining guaranteed amount, and, for lifetime GWWB products, the annuity payments can
continue beyond the guaranteed amount. The account value can also fluctuate with equity market returns on a
daily basis resulting in increases or decreases in the excess of the guaranteed amount over account value.
The net impact of the change in the fair value of the embedded derivative liabilities, as well as the change in
the fair value of the derivative instruments is included in Net Realized Capital Gains (Losses).
For a further discussion of the risks of AIG’s unhedged exposures, see Item 1A. — Risk Factors — Guarantees
Within Variable Annuities.
Estimated gross profits (EGP) are subject to differing market returns and interest rate environments in any
single period. EGP is composed of net interest income, net realized investment gains and losses, fees, surrender
charges, expenses, and mortality and morbidity gains and losses. When assumptions are changed, the percentage of
EGP used to amortize DAC might also change.
In estimating EGP, AIG makes certain assumptions regarding the investment returns to be generated, market
interest rates and mortality rates. Changes in any of these assumptions could materially change the amortization of
DAC and related balances.
184 AIG 2011 Form 10-K
ESTIMATED GROSS PROFITS FOR INTEREST-SENSITIVE PRODUCTS
(SUNAMERICA COMPANIES):