AIG 2011 Annual Report Download - page 256

American International Group, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
•Level 2: Fair value measurements based on inputs other than quoted prices included in Level 1, that are
observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for
similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in
markets that are not active, and inputs other than quoted prices that are observable for the asset or liability,
such as interest rates and yield curves that are observable at commonly quoted intervals. Assets and
liabilities measured at fair value on a recurring basis and classified as Level 2 generally include certain
government and agency securities, most investment-grade and high-yield corporate bonds, certain residential
mortgage-backed securities (RMBS), certain commercial mortgage-backed securities (CMBS) and certain
collateralized debt obligations/asset backed securities (CDO/ABS), certain listed equities, state, municipal
and provincial obligations, hybrid securities, certain securities purchased (sold) under agreements to resell
(repurchase), certain mutual fund and hedge fund investments, certain interest rate, currency and commodity
derivative contracts, guaranteed investment agreements (GIAs) for the Direct Investment book and other
long-term debt.
•Level 3: Fair value measurements based on valuation techniques that use significant inputs that are
unobservable. Both observable and unobservable inputs may be used to determine the fair values of
positions classified in Level 3. The circumstances for using these measurements include those in which there
is little, if any, market activity for the asset or liability. Therefore, AIG must make certain assumptions as to
the inputs a hypothetical market participant would use to value that asset or liability. In certain cases, the
inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the
level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined
based on the lowest level input that is significant to the fair value measurement in its entirety. AIG’s
assessment of the significance of a particular input to the fair value measurement in its entirety requires
judgment. In making the assessment, AIG considers factors specific to the asset or liability. Assets and
liabilities measured at fair value on a recurring basis and classified as Level 3 include certain RMBS, CMBS
and CDO/ABS, certain corporate debt securities, certain municipal and sovereign debt securities, certain
derivative contracts (including the AIGFP super senior credit default swap portfolio), certain hedge fund
investments, private equity and real estate fund investments, direct private equity investments and
policyholder contract deposits carried at fair value. AIG’s non-financial instrument assets that are measured
at fair value on a non-recurring basis generally are classified as Level 3.
The following is a description of the valuation methodologies used for instruments carried at fair value. These
methodologies are applied to assets and liabilities across the levels noted above, and it is the observability of the
inputs used that determines the appropriate level in the fair value hierarchy for the respective asset or liability.
Incorporation of Credit Risk in Fair Value Measurements
•AIG’s Own Credit Risk. Fair value measurements for certain Direct Investment book debt, GIAs, structured
note liabilities and freestanding derivatives, as well as AIGFP derivatives, incorporate AIG’s own credit risk
by determining the explicit cost for each counterparty to protect against its net credit exposure to AIG at
the balance sheet date by reference to observable AIG CDS or cash bond spreads. A derivative
counterparty’s net credit exposure to AIG is determined based on master netting agreements, when
applicable, which take into consideration all derivative positions with AIG, as well as collateral posted by
AIG with the counterparty at the balance sheet date.
Fair value measurements for embedded policy derivatives and policyholder contract deposits take into
consideration that policyholder liabilities are senior in priority to general creditors of AIG and therefore
are much less sensitive to changes in AIG credit default swap or cash issuance spreads.
242 AIG 2011 Form 10-K
VALUATION METHODOLOGIES OF FINANCIAL INSTRUMENTS MEASURED AT
FAIR VALUE