AIG 2011 Annual Report Download - page 264

American International Group, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
simulation scenario and, if it does, the security’s implied random default time and expected loss. This information
is used to project cash flow streams and to determine the expected losses of the portfolio.
In addition to calculating an estimate of the fair value of the super senior CDO security referenced in the credit
default swaps using its internal model, AIG also considers the price estimates for the super senior CDO securities
provided by third parties, including counterparties to these transactions, to validate the results of the model and to
determine the best available estimate of fair value. In determining the fair value of the super senior CDO security
referenced in the credit default swaps, AIG uses a consistent process that considers all available pricing data
points and eliminates the use of outlying data points. When pricing data points are within a reasonable range an
averaging technique is applied.
Corporate debt/Collateralized loan obligation (CLO) portfolios: In the case of credit default swaps written on
portfolios of investment-grade corporate debt, AIG uses a mathematical model that produces results that are
closely aligned with prices received from third parties. This methodology is widely used by other market
participants and uses the current market credit spreads of the names in the portfolios along with the base
correlations implied by the current market prices of comparable tranches of the relevant market traded credit
indices as inputs. Given its unique attributes, one transaction, which had represented two percent of the total
notional amount of the corporate debt portfolio as of the second quarter of 2011, was valued using third-party
quotations. This transaction matured in the third quarter of 2011.
AIG estimates the fair value of its obligations resulting from credit default swaps written on CLOs to be
equivalent to the par value less the current market value of the referenced obligation. Accordingly, the value is
determined by obtaining third-party quotations on the underlying super senior tranches referenced under the
credit default swap contract.
Policyholder Contract Deposits
Policyholder contract deposits accounted for at fair value are measured using an earnings approach by taking
into consideration the following factors:
• Current policyholder account values and related surrender charges;
• The present value of estimated future cash inflows (policy fees) and outflows (benefits and maintenance
expenses) associated with the product using risk neutral valuations, incorporating expectations about
policyholder behavior, market returns and other factors; and
• A risk margin that market participants would require for a market return and the uncertainty inherent in the
model inputs.
The change in fair value of these policyholder contract deposits is recorded as Policyholder benefits and claims
incurred in the Consolidated Statement of Operations.
Other Long-Term Debt
When fair value accounting has been elected, the fair value of non-structured liabilities is generally determined
by using market prices from exchange or dealer markets, when available, or discounting expected cash flows using
the appropriate discount rate for the applicable maturity. Such instruments are generally classified in Level 2 of
the fair value hierarchy as substantially all inputs are readily observable. AIG determines the fair value of
structured liabilities and hybrid financial instruments (where performance is linked to structured interest rates,
inflation or currency risks) using the appropriate derivative valuation methodology (described above) given the
nature of the embedded risk profile. Such instruments are classified in Level 2 or Level 3 depending on the
observability of significant inputs to the model. In addition, adjustments are made to the valuations of both
250 AIG 2011 Form 10-K