AIG 2007 Annual Report Download - page 175

American International Group, Inc. and Subsidiaries
majority of the losses would be incurred in the first year. The In addition, AIGFP utilizes various credit enhancements, includ-
modeled losses calculated were based on 2006 policy data ing letters of credit, guarantees, collateral, credit triggers, credit
representing approximately 92 percent of AIG’s individual life, derivatives and margin agreements to reduce the credit risk
group life and credit life books of business, net of reinsurance. relating to its outstanding financial derivative transactions. AIGFP
This estimate does not include claims that could be made under requires credit enhancements in connection with specific transac-
other policies, such as business interruption or general liability tions based on, among other things, the creditworthiness of the
policies, and does not reflect estimates for losses resulting from counterparties, and the transaction’s size and maturity. Further-
disruption of AIG’s own business operations or asset losses that more, AIGFP generally seeks to enter into agreements that have
may arise out of such a pandemic. The model used to generate the benefit of set-off and close-out netting provisions. These
this estimate has only recently been developed. The reasonable- provisions provide that, in the case of an early termination of a
ness of the model and its underlying assumptions cannot readily transaction, AIGFP can setoff its receivables from a counterparty
be verified by reference to comparable historical events. As a against its payables to the same counterparty arising out of all
result, AIG’s actual losses from a pandemic influenza outbreak covered transactions. As a result, where a legally enforceable
are likely to vary significantly from those predicted by the model. netting agreement exists, the fair value of the transaction with the
counterparty represents the net sum of estimated positive fair
values. The fair value of AIGFP’s interest rate, currency, commod-
Financial Services
ity and equity swaps, options, swaptions, and forward commit-
AIG’s Financial Services subsidiaries engage in diversified activi- ments, futures, and forward contracts approximated
ties including aircraft and equipment leasing, capital markets, $17.13 billion at December 31, 2007 and $19.61 billion at
consumer finance and insurance premium finance. December 31, 2006. Where applicable, these amounts have been
determined in accordance with the respective master netting
Capital Markets agreements.
AIGFP evaluates the counterparty credit quality by reference to
The Capital Markets operations of AIG are conducted primarily
ratings from rating agencies or, where such ratings are not
through AIGFP, which engages as principal in standard and
available, by internal analysis consistent with the risk rating
customized interest rate, currency, equity, commodity, energy and
policies of the CRC. In addition, AIGFP’s credit approval process
credit products with top-tier corporations, financial institutions,
involves pre-set counterparty and country credit exposure limits
governments, agencies, institutional investors and high-net-worth
and, for particularly credit-intensive transactions, requires approval
individuals throughout the world.
from the CRC. AIG estimates that the average credit rating of
The senior management of AIG defines the policies and
Capital Markets derivatives counterparties, measured by reference
establishes general operating parameters for Capital Markets
to the fair value of its derivative portfolio as a whole, is equivalent
operations. AIG’s senior management has established various
to the AA rating category.
oversight committees to monitor on an ongoing basis the various
financial market, operational and credit risk attendant to the
Capital Markets operations. The senior management of AIGFP At December 31, 2007 and 2006, the fair value of Capital Markets
reports the results of its operations to and reviews future derivatives portfolios by counterparty credit rating was as follows:
strategies with AIG’s senior management.
(in millions) 2007 2006
AIGFP actively manages its exposures to limit potential eco-
nomic losses, while maximizing the rewards afforded by these Rating:
business opportunities even though some products or derivatives AAA $ 5,069 $ 5,465
may result in operating income volatility. In doing so, AIGFP must AA 5,166 8,321
continually manage a variety of exposures including credit, market, A4,796 3,690
liquidity, operational and legal risks. BBB 1,801 2,032
Below investment grade 302 99
Derivative Transactions Total $17,134 $19,607
A counterparty may default on any obligation to AIG, including a
derivative contract. Credit risk is a consequence of extending Credit Derivatives
credit and/or carrying trading and investment positions. Credit risk AIGFP enters into credit derivative transactions in the ordinary
exists for a derivative contract when that contract has a positive course of its business. The majority of AIGFP’s credit derivatives
fair value to AIG. The maximum potential exposure will increase or require AIGFP to provide credit protection on a designated
decrease during the life of the derivative commitments as a portfolio of loans or debt securities. AIGFP provides such credit
function of maturity and market conditions. To help manage this protection on a ‘‘second loss’’ basis, under which AIGFP’s
risk, AIGFP’s credit department operates within the guidelines set payment obligations arise only after credit losses in the desig-
by the CRC. Transactions which fall outside these pre-established nated portfolio exceed a specified threshold amount or level of
guidelines require the specific approval of the CRC. It is also ‘‘first losses.’’ The threshold amount of credit losses that must
AIG’s policy to establish reserves for potential credit impairment be realized before AIGFP has any payment obligation is negotiated
when necessary.
AIG 2007 Form 10-K 121