AIG 2006 Annual Report Download - page 144

American International Group, Inc. and Subsidiaries
Management’s Discussion and Analysis of
Financial Condition and Results of Operations Continued
policies, and does not reflect estimates for losses resulting from determine that it is economically advantageous to be temporarily
disruption of AIG’s own business operations that may arise out of in an unmatched position.
such a pandemic. The model used to generate this estimate has
only recently been developed. The reasonableness of the model Financial Services
and its underlying assumptions cannot readily be verified by AIG’s Financial Services subsidiaries engage in diversified activi-
reference to comparable historical events. As a result, AIG’s ties including aircraft and equipment leasing, capital markets,
actual losses from a pandemic influenza outbreak are likely to consumer finance and insurance premium finance.
vary significantly from those predicted by the model.
Aircraft Leasing
Investments
AIG’s Aircraft Leasing operations represent the operations of ILFC,
AIG’s fixed maturity investments totaled $417.9 billion at Decem- which generates its revenues primarily from leasing new and used
ber 31, 2006, compared to $385.7 billion at December 31, commercial jet aircraft to scheduled and charter airlines and
2005. AIG’s investment strategies are tailored to the specific companies associated with the airline industry. Risks inherent in
business needs of each operating unit based on considerations this business, and which are managed at the business unit level,
that include the local market, liability duration and cash flow include: (i) the risk that there will be no market for the aircraft
characteristics, rating agency and regulatory capital considera- acquired; (ii) the risk that aircraft cannot be placed with lessees;
tions, legal investment limitations, tax optimization, diversification (iii) the risk of nonperformance by lessees; and (iv) the risk that
and credit limits. These strategies are intended to produce a aircraft and related assets cannot be disposed of at the time and
reasonably stable and predictable return throughout the economic in a manner desired.
cycle, without undue risk or volatility.
At December 31, 2006, approximately 57 percent of the fixed Capital Markets
maturities investments were domestic securities. Approximately
39 percent of such domestic securities were rated AAA by one or The Capital Markets operations of AIG are conducted primarily
more of the principal rating agencies. Approximately five percent through AIGFP, which engages as principal in standard and
were below investment grade or not rated. customized interest rate, currency, equity, commodity, energy and
A significant portion of the foreign fixed income portfolio is credit products with top-tier corporations, financial institutions,
rated by Moody’s, S&P or similar foreign rating services. Rating governments, agencies, institutional investors and high-net-worth
services are not available in all overseas locations. The CRC individuals throughout the world.
closely reviews the credit quality of the foreign portfolio’s non- The senior management of AIG defines the policies and
rated fixed income investments. At December 31, 2006, approxi- establishes general operating parameters for Capital Markets
mately 20 percent of the foreign fixed income investments were operations. AIG’s senior management has established various
either rated AAA or, on the basis of AIG’s internal analysis, were oversight committees to monitor on an ongoing basis the various
equivalent from a credit standpoint to securities so rated. financial market, operational and credit risk attendant to the
Approximately five percent were below investment grade or not Capital Markets operations. The senior management of AIGFP
rated at that date. A large portion of the foreign fixed income reports the results of its operations to and reviews future
portfolio is sovereign fixed maturity securities supporting the strategies with AIG’s senior management.
policy liabilities in the country of issuance. AIGFP actively manages its exposures to limit potential losses,
The credit ratings of fixed maturity investments, other than while maximizing the rewards afforded by these business opportu-
those of AIGFP, at December 31, 2006 were:nities. In doing so, AIGFP must continually manage a variety of
exposures including credit, market, liquidity, operational and legal
2006 risks.
AAA 31% AIGFP enters into credit derivative transactions in the ordinary
AA 26 course of its business. The majority of AIGFP’s credit derivatives
A23 require AIGFP to provide credit protection on a designated
BBB 14 portfolio of loans or debt securities. AIGFP provides such credit
Below investment grade 4protection on a ‘‘second loss’’ basis, under which AIGFP’s
Non-rated 2
payment obligations arise only after credit losses in the desig-
Total 100% nated portfolio exceed a specified threshold amount or level of
AIG uses asset-liability matching as a management tool ‘‘first losses.’’ The threshold amount of credit losses that must
worldwide in the life insurance business to determine the be realized before AIGFP has any payment obligation is negotiated
composition of the invested assets and appropriate marketing by AIGFP for each transaction to provide that the likelihood of any
strategies. AIG’s objective is to maintain a matched asset-liability payment obligation by AIGFP under each transaction is remote,
structure. However, in certain markets, the absence of long-dated even in severe recessionary market scenarios.
fixed income instruments may preclude a matched asset-liability In certain cases, the credit risk associated with a designated
position in those markets. In addition, AIG may occasionally portfolio is tranched into different layers of risk, which are then
analyzed and rated by the credit rating agencies. Typically, there
94 AIG 2006 Form 10-K