AIG 2013 Annual Report Download - page 262

Corporate debt securities included in Level 3 are primarily private placement issuances that are not traded in active
markets or that are subject to transfer restrictions. Fair value measurements consider illiquidity and
non-transferability. When observable price quotations are not available, fair value is determined based on discounted
cash flow models using discount rates based on credit spreads, yields or price levels of publicly-traded debt of the
issuer or other comparable securities, considering illiquidity and structure. The significant unobservable input used in
the fair value measurement of corporate debt is the yield. The yield is affected by the market movements in credit
spreads and U.S. Treasury yields. In addition, the migration in credit quality of a given security generally has a
corresponding effect on the fair value measurement of the security. For example, a downward migration of credit
quality would increase spreads. Holding U.S. Treasury rates constant, an increase in corporate credit spreads would
decrease the fair value of corporate debt.
The significant unobservable inputs used in fair value measurements of RMBS and certain CDO/ABS valued by third-
party valuation service providers are constant prepayment rates (CPR), loss severity, constant default rates (CDR),
and yield. A change in the assumptions used for the probability of default will generally be accompanied by a
corresponding change in the assumption used for the loss severity and an inverse change in the assumption used for
prepayment rates. In general, increases in CPR, loss severity, CDR, and yield, in isolation, would result in a
decrease in the fair value measurement. Changes in fair value based on variations in assumptions generally cannot
be extrapolated because the relationship between the directional change of each input is not usually linear.
The significant unobservable input used in fair value measurements for CMBS is the yield. Prepayment assumptions
for each mortgage pool are factored into the yield. CMBS generally feature a lower degree of prepayment risk than
RMBS because commercial mortgages generally contain a penalty for prepayment. In general, increases in the yield
would decrease the fair value of CMBS.
The significant unobservable inputs used for certain CDO/ABS securities valued using the BET are recovery rates,
diversity score, and the weighted average life of the portfolio. An increase in recovery rates and diversity score will
increase the fair value of the portfolio. An increase in the weighted average life will decrease the fair value.
Embedded derivatives within Policyholder contract deposits relate to guaranteed minimum withdrawal benefits
(GMWB) within variable annuity products and certain enhancements to interest crediting rates based on market
indices within equity-indexed annuities and guaranteed investment contracts (GICs). GMWB represents our largest
exposure of these embedded derivatives, although the carrying value of the liability fluctuates based on the
performance of the equity markets and therefore, at a point in time, can be low relative to the exposure. The principal
unobservable input used for GMWBs and embedded derivatives in equity-indexed annuities measured at fair value is
equity implied volatility. For GMWBs, other significant unobservable inputs include base and dynamic lapse rates,
mortality rates, and utilization rates. Lapse, mortality, and utilization rates may vary significantly depending upon age
groups and duration. In general, increases in volatility and utilization rates will increase the fair value of the liability
associated with GMWB, while increases in lapse rates and mortality rates will decrease the fair value of the liability.
Significant unobservable inputs used in valuing embedded derivatives within GICs include long-term forward interest
rates and foreign exchange rates. Generally, the embedded derivative liability for GICs will increase as interest rates
decrease or if the U.S. dollar weakens compared to the euro.
Corporate Debt
RMBS and Certain CDO/ABS
CMBS
CDO/ABS — Direct Investment book
Policyholder contract deposits
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AIG 2013 Form 10-K244
ITEM 8 / NOTE 5. FAIR VALUE MEASUREMENTS
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