AIG 2015 Annual Report Download - page 261

ITEM 8 / NOTE 4. FAIR VALUE MEASUREMENTS
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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.
RMBS and CDO/ABS
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.
CMBS
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.
Embedded derivatives within Policyholder contract deposits
Embedded derivatives reported within Policyholder contract deposits include guaranteed minimum withdrawal benefits
(GMWB) and guaranteed minimum accumulation benefits (GMAB) within variable annuity products, and certain enhancements
to interest crediting rates based on market indices within index annuities, indexed life and guaranteed investment contracts
(GICs). For any given contract, assumptions for unobservable inputs vary throughout the period over which cash flows are
projected for purposes of valuing the embedded derivative. The following unobservable inputs are used for valuing embedded
derivatives measured at fair value:
 Long-term equity volatilities represent equity volatility beyond the period for which observable equity volatilities are
available. Increases in assumed volatility will generally increase the fair value of both the projected cash flows from rider
fees as well as the projected cash flows related to benefit payments. Therefore, the net change in the fair value of the
liability may either decrease or increase, depending on the relative changes in projected rider fees and projected benefit
payments. In 2015, the calculations used to measure equity volatilities for the GMWB and GMAB were updated to provide
greater emphasis on current expected market-based volatilities versus historical market volatilities. The implementation of
this change reduced the fair value of the GMWB and GMAB liabilities, net of related adjustments to DAC, by
approximately $143 million at December 31, 2015, which was more than offset by the addition of an equity / interest rate
correlation factor to the valuation model in 2015, as described below. Long-term equity volatility and equity / interest rate
correlation are both key inputs in our economic scenario modeling used to value the embedded derivatives.
 Equity / interest rate correlation estimates the relationship between changes in equity returns and interest rates in the
economic scenario generator used to value our GMWB and GMAB embedded derivatives. In general, a higher positive
correlation assumes that equity markets and interest rates move in a more correlated fashion, which generally increases
the fair value of the liability. Prior to 2015, an assumption of zero correlation was used based on historical data that was
mixed as to the direction of this correlation over a long period of time. In 2015, we added a positive correlation factor
based on current market conditions and expected views of market participants. This change increased the GMWB and
GMAB fair value liabilities, net of related adjustments to DAC, by approximately $155 million at December 31, 2015, which
was largely offset by an update to equity volatility assumptions, as described above.