AIG 2006 Annual Report Download - page 146

American International Group, Inc. and Subsidiaries
Management’s Discussion and Analysis of
Financial Condition and Results of Operations Continued
At December 31, 2006 and 2005, the distribution by AIGFP’s minimal reliance on market risk driven revenue is
counterparty credit quality with respect to the fair value of reflected in its VaR. AIGFP’s VaR calculation is based on the
Capital Markets derivatives portfolios was as follows: interest rate, equity, commodity and foreign exchange risk arising
from its portfolio. Because the market risk with respect to
Percentage of securities available for sale, at market, is substantially hedged,
Total Fair Value
segregation of the financial instruments into trading and other
2006 2005
than trading was not deemed necessary.
Counterparty credit quality: In the calculation of VaR for AIGFP, AIG uses the historical
AAA 28% 24% simulation methodology that entails repricing all transactions
AA 41 43 under explicit changes in market rates within a specific historical
A19 21 time period. AIGFP attempts to secure reliable and independent
BBB 11 9current market prices, such as published exchange prices,
Below investment grade 13external subscription services such as Bloomberg or Reuters, or
Total 100% 100% third-party broker quotes. When such prices are not available,
AIGFP uses an internal methodology which includes extrapolation
from observable and verifiable prices nearest to the dates of the
Capital Markets Trading VaR
transactions. Historically, actual results have not deviated from
AIGFP maintains a very conservative market risk profile and these models in any material respect.
minimizes risk in interest rates, equities, commodities and foreign AIGFP reports its VaR using a 95 percent confidence interval
exchange. Market exposures in option implied volatilities, correla- and a one-day holding period, facilitating risk comparison with
tions and basis risks are also minimized over time but those are AIGFP’s trading peers and reflecting the fact that market risks can
the main types of market risks that AIGFP manages. As a result, be actively assumed and offset in AIGFP’s trading portfolio.
AIGFP’s operating income due to changes in market prices and
rates is generally a very small percentage of its overall operating
income.
The following table presents the year-end, average, high, and low VaRs on a diversified basis and of each component of market risk
for Capital Markets operations for the years 2006 and 2005. The diversified VaR is usually smaller than the sum of its components
due to correlation effects.
For the Year Ended For the Year Ended
December 31, 2006 December 31, 2005
(in millions) As of December 31 Average High Low As of December 31 Average High Low
Total AIG trading market risk:
Diversified $4 $4 $7 $3 $5 $4 $7 $3
Interest rate 2231 2231
Currency 1131 111—
Equity 3342 325—
Commodity 3342 2231
* In 2006, VaR calculations were changed from a 30-day holding period to a one-day holding period. Accordingly, the 2005 VaR amounts have been
restated to reflect this change.
Consumer Finance these loans. AGF manages the credit risk inherent in its portfolio
by using credit scoring models at the time of credit applications,
AIG’s Consumer Finance operations provide a wide variety of established underwriting criteria, and, in certain cases, individual
consumer finance products, including real estate and other loan reviews. AGF monitors the quality of the finance receivables
consumer loans, credit card loans, retail sales finance and credit- por tfolio and determines the appropriate level of the allowance for
related insurance to customers both domestically and overseas, losses through its Credit Strategy and Policy Committee. This
particularly in emerging markets. Consumer Finance operations Committee bases its conclusions on quantitative analyses, quali-
include AGF as well as AIGCFG. AGF provides a wide variety of tative factors, current economic conditions and trends, and each
consumer finance products, including real estate loans, non-real Committee member’s experience in the consumer finance indus-
estate loans, retail sales finance and credit-related insurance to try. Through 2006, the credit quality of AGF’s finance receivables
customers in the United States, Puerto Rico and the U.S. Virgin continued to be strong. However, declines in the strength of the
Islands. AIGCFG, through its subsidiaries, is engaged in develop- U.S. housing market or economy may adversely affect the future
ing a multi-product consumer finance business with an emphasis credit quality of these receivables.
on emerging markets. AIGCFG monitors the quality of its finance receivable portfolio
Many of AGF’s borrowers are non-prime or sub-prime. Current and determines the appropriate level of the allowance for losses
economic conditions, such as interest rate and employment through several internal committees. These committees base their
levels, can have a direct effect on the borrowers’ ability to repay
96 AIG 2006 Form 10-K