AIG 2011 Annual Report Download - page 309

American International Group, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
These contracts were written through AIG Markets, which then transacted directly with unaffiliated third parties
under ISDA agreements. As of December 31, 2011, the notional amount of written CDS contracts was $1.1 billion
with an average credit rating of BBB+. At that date, the average remaining maturity of the written CDS contracts
was less than one year and the fair value of the derivative liability (which represents the carrying value) of the
MIP’s written CDS contracts was $13 million.
The majority of the ISDA agreements include CSA provisions, which provide for collateral postings at various
ratings and threshold levels. At December 31, 2011, $2 million of collateral was posted for CDS contracts related
to the MIP. The notional amount represents the maximum exposure to loss on the written CDS contracts.
However, because of the average investment grade rating and expected default recovery rates, actual losses are
expected to be less.
Upon a triggering event (e.g., a default) with respect to the underlying credit, AIG Markets would normally
have the option to settle the position on behalf of the MIP through an auction process (cash settlement) or pay
the notional amount of the contract to the counterparty in exchange for a bond issued by the underlying credit
(physical settlement).
Credit Risk-Related Contingent Features
AIG engages in derivative transactions directly with unaffiliated third parties under ISDA agreements. Many of
the ISDA agreements also include CSA provisions, which provide for collateral postings at various ratings and
threshold levels. In addition, AIG attempts to reduce credit risk with certain counterparties by entering into
agreements that enable collateral to be obtained from a counterparty on an upfront or contingent basis.
The aggregate fair value of AIG’s derivative instruments, including those of AIGFP, that contain credit
risk-related contingent features that were in a net liability position at December 31, 2011, was approximately
$4.9 billion. The aggregate fair value of assets posted as collateral under these contracts at December 31, 2011,
was $5.1 billion.
AIG estimates that at December 31, 2011, based on AIG’s outstanding financial derivative transactions,
including those of AIGFP at that date, a one-notch downgrade of AIG’s long-term senior debt ratings to BBB+
by Standard & Poor’s Financial Services LLC, a subsidiary of The McGraw-Hill Companies, Inc. (S&P), would
permit counterparties to make additional collateral calls and permit the counterparties to elect early termination
of contracts, resulting in a negligible amount of corresponding collateral postings and termination payments; a
one-notch downgrade to Baa2 by Moody’s Investors’ Services, Inc. (Moody’s) and an additional one-notch
downgrade to BBB by S&P would result in approximately $264 million in additional collateral postings and
termination payments and a further one-notch downgrade to Baa3 by Moody’s and BBB- by S&P would result in
approximately $267 million in additional collateral postings and termination payments. Additional collateral
postings upon downgrade are estimated based on the factors in the individual collateral posting provisions of the
CSA with each counterparty and current exposure as of December 31, 2011. Factors considered in estimating the
termination payments upon downgrade include current market conditions, the complexity of the derivative
transactions, historical termination experience and other observable market events such as bankruptcy and
downgrade events that have occurred at other companies. Management’s estimates are also based on the
assumption that counterparties will terminate based on their net exposure to AIG. The actual termination
payments could significantly differ from management’s estimates given market conditions at the time of downgrade
and the level of uncertainty in estimating both the number of counterparties who may elect to exercise their right
to terminate and the payment that may be triggered in connection with any such exercise.
AIG 2011 Form 10-K 295