AIG 2005 Annual Report Download - page 134

Notes to Consolidated Financial Statements Continued
the transactions prior to maturity. AIG believes that such
1. Summary of Significant Accounting Policies
differences are not significant to the financial condition or
Continued
liquidity. Such differences would be immediately recognized in
FAS 133, the unrealized gains and losses on these securities income when the transactions are sold or closed out prior to
resulting from changes in interest rates, currency rates and maturity.
equity prices are recorded in consolidated shareholders’ equity
while the unrealized gains and losses on the related economic (j) Financial Services – Trading Assets and Trading Liabilities:
hedges are reflected in operating income. Trading assets and trading liabilities include option premiums
paid and received and receivables from and payables to
(g) Financial Services – Trading Securities, at market value: counterparties which relate to unrealized gains and losses on
Trading securities are held to meet short term investment futures, forwards, and options and balances due from and due
objectives, including hedging securities. These securities are to clearing brokers and exchanges.
recorded on a trade-date basis and carried at current market Futures, forwards, and options purchased and written are
values. Unrealized gains and losses are reflected in income accounted for as derivatives on a trade-date basis and are
currently. carried at fair values. Unrealized gains and losses are reflected
in income currently. The fair values of futures contracts are
(h) Financial Services – Spot Commodities: Spot commodities
based on closing exchange quotations. Commodity forward
are carried at lower of cost or market value and are recorded
transactions are carried at fair values derived from dealer
on a trade-date basis. The exposure to market risk may be
quotations and underlying commodity exchange quotations. For
reduced through the use of forwards, futures and option
long-dated forward transactions, where there are no dealer or
contracts. Lower of cost or market value reductions in
exchange quotations, fair values are derived using internally
commodity positions and unrealized gains and losses in related
developed valuation methodologies based on observable and
derivatives are reflected in income currently.
available market information. Options are carried at fair values
(i) Financial Services – Unrealized Gain and Unrealized Loss based on the use of valuation models that utilize, among other
on Swaps, Options and Forward Transactions: Interest rate, things, current interest or commodity rates, and foreign
currency, equity and commodity swaps, swaptions, options and exchange and volatility rates, as applicable.
forward transactions are accounted for as derivatives recorded
(k) Financial Services – Securities Purchased (Sold) Under
on a trade-date basis and are carried at current market values
Agreements to Resell (Repurchase), at contract value:
or estimated fair values when market values are not available.
Purchases of securities under agreements to resell and sales of
Unrealized gains and losses are reflected in income currently,
securities under agreements to repurchase are accounted for as
where appropriate. In certain instances, when income is not
collateralized borrowing or lending transactions and are re-
recognized upfront under EITF 02-03, ‘‘Issues Involved in
corded at their contracted resale or repurchase amounts, plus
Accounting for Derivative Contracts Held for Trading Purposes
accrued interest. AIG’s policy is to take possession of or obtain
and Contracts Involved in Energy Trading and Risk Manage-
a security interest in securities purchased under agreements to
ment Activities’’, (EITF 02-03), income is recognized over the
resell.
life of the contract. Estimated fair values are based on the use
AIG minimizes the credit risk that counterparties to
of valuation models that utilize, among other things, current
transactions might be unable to fulfill their contractual
interest, foreign exchange, equity, commodity and volatility
obligations by monitoring customer credit exposure and collat-
rates. AIG attempts to secure reliable and independent current
eral value and generally requiring additional collateral to be
market prices, such as published exchange prices, external
deposited with AIG when deemed necessary.
subscription services’ prices such as Bloomberg or Reuters or
third-party broker quotes for use in its models. When such (l) Financial Services – Finance Receivables: Finance receiv-
prices are not available, AIG uses an internal methodology ables are carried at amortized cost which includes accrued
which includes interpolation and extrapolation from observable finance charges on interest bearing finance receivables, unam-
and verifiable prices nearest to the dates of the transactions. ortized deferred origination costs, and unamortized net premi-
These valuations represent an assessment of the present values ums and discounts on purchased finance receivables. They are
of expected future cash flows of these transactions and reflect net of unamortized finance charges and unamortized points and
market and credit risk. The portfolio’s discounted cash flows fees. The allowance for finance receivable losses is established
are evaluated with reference to current market conditions, through the provision for finance receivable losses charged to
maturities within the portfolio, and other relevant factors. expense.
Based upon this evaluation, it is determined what offsetting
transactions, if any, are necessary to reduce the market risk of (m) Securities Lending Collateral and Securities Lending
the portfolio. AIG manages its market risk with a variety of Payable: AIG’s insurance and asset management operations
transactions, including swaps, trading securities, futures and lend their securities and primarily take cash as collateral with
forward contracts and other transactions as appropriate. Be- respect to the securities lent. Invested collateral consists
cause of the limited liquidity of some of these instruments, the primarily of floating rate debt securities. Income earned on
recorded values of these transactions may be different from the invested collateral, net of interest payable to the collateral
values that might be realized if AIG were to sell or close out provider, is recorded in net investment income.
82 AIG m Form 10-K