AIG 2007 Annual Report Download - page 169

American International Group, Inc. and Subsidiaries
these securities initially had underlying investment grade ratings, capital. Similar to the income statement, AIG’s overall balance
poor pool performance has in some cases resulted in current sheet is net long foreign currencies and net short U.S. dollars.
ratings of below investment grade. The amount of ultimate loss
exposure of these securities to the monoline insurers is a The table below provides an estimate of the sensitivity of
function of the ultimate performance of the collateral pools and shareholders’ equity and net income to 10 percent changes in
cannot be reliably estimated. AIG believes that monoline insurers the value of the U.S. dollar relative to foreign currencies as of
are currently providing payment support on approximately December 31, 2007, assuming a tax rate of 35 percent:
$380 million of such securities. U.S. dollar up U.S. dollar down
The CRC reviews quarterly concentration reports in all catego- (in millions) 10 percent 10 percent
ries listed above as well as credit trends by risk ratings. The CRC Shareholders’ equity $(466) $466
may adjust limits to provide reasonable assurance that AIG does Net income $(220) $220
not incur excessive levels of credit risk and that AIG’s credit risk AIG analyzes market risk using various statistical techniques
profile is properly calibrated across business units. including Value at Risk (VaR). VaR is a summary statistical
measure that uses the estimated volatility and correlation of
Market Risk Management market factors to calculate the maximum loss that could occur
AIG is exposed to market risks, primarily within its insurance and over a defined period of time with a specified level of statistical
capital markets businesses. These asset-liability exposures are confidence. VaR measures not only the size of individual expo-
predominantly structural in nature, and not the result of specula- sures but also the interaction between different market expo-
tive positioning to take advantage of short-term market opportuni- sures, thereby providing a portfolio approach to measuring market
ties. The Market Risk Management department (MRM), which risk. Similar VaR methodologies are used to determine capital
reports to the CRO, is responsible for control and oversight of requirements for market risk within AIG’s economic capital
market risks in all aspects of AIG’s financial services, insurance, framework.
and investment activities.
Insurance, Asset Management and Non-Trading Financial Services
AIG’s market exposures arise from the following: VaR
(AIG is a globally diversified enterprise with capital deployed in a
variety of currencies. Capital deployed in AIG’s overseas AIG performs one comprehensive VaR analysis across all of its
businesses, when converted into U.S. dollars for financial non-trading businesses, and a separate VaR analysis for its
reporting purposes, constitutes a ‘‘long foreign currency/short trading business at AIGFP. The comprehensive VaR is categorized
U.S. dollar’’ market exposure on AIG’s balance sheet. Similarly, by AIG business segment (General Insurance, Life Insurance &
overseas earnings denominated in foreign currency also repre- Retirement Services, Financial Services and Asset Management)
sent a ‘‘long foreign currency/short U.S. dollar’’ market and also by market risk factor (interest rate, currency and equity).
exposure on AIG’s income statement. AIG’s market risk VaR calculations include exposures to bench-
(Much of AIG’s domestic capital is invested in U.S. fixed income mark Treasury or swap interest rates, but do not include
or equity securities, leading to exposures to U.S. yields and exposures to credit-based factors such as credit spreads. AIG’s
equity markets. credit exposures within its invested assets and credit derivative
(Several of AIG’s Foreign Life Insurance subsidiaries operate in portfolios are discussed in Credit Risk Management — Financial
developing markets where maturities on longer-term life insur- Services herein.
ance liabilities exceed the maximum maturities of available For the insurance segments, assets included are invested
local currency assets. assets (excluding direct holdings of real estate) and liabilities
As a globally diversified enterprise, AIG is exposed to a variety included are reserve for losses and loss expenses, reserve for
of foreign currency risks. AIG earns a significant portion of its unearned premiums, future policy benefits for life and accident
income from operations conducted in foreign currencies which and health insurance contracts and other policyholders’ funds. For
must be translated into U.S. dollars for consolidated reporting financial services companies, loans and leases represent the
purposes. Consequently, exchange rate fluctuations can cause majority of assets represented in the VaR calculation, while bonds
volatility in AIG’s reported earnings. When the U.S. dollar weakens and notes issued represent the majority of liabilities.
against other currencies, AIG’s earnings increase. When the AIG calculated the VaR with respect to net fair values as of
U.S. dollar strengthens against other currencies, AIG’s earnings December 31, 2007 and 2006. The VaR number represents the
decline. maximum potential loss as of those dates that could be incurred
The sensitivity of AIG’s consolidated shareholders’ equity to with a 95 percent confidence (i.e., only five percent of historical
foreign exchange volatility is more complex. AIG has significant scenarios show losses greater than the VaR figure) within a one-
capital committed overseas, which rises in value on AIG’s month holding period. AIG uses the historical simulation methodol-
consolidated balance sheet when the U.S. dollar weakens. AIG ogy that entails repricing all assets and liabilities under explicit
also has significant U.S. dollar asset holdings overseas, which changes in market rates within a specific historical time period.
offset the foreign exchange exposure arising from AIG’s overseas AIG uses the most recent three years of historical market
information for interest rates, foreign exchange rates, and equity
AIG 2007 Form 10-K 115