AIG 2007 Annual Report Download - page 87

American International Group, Inc. and Subsidiaries
other invested assets have correspondingly dropped over the next 12 to 18 months by AIGFP’s counterparties as they
same period. New regulatory capital requirements being devel- implement models compliant with the new Basel II Accord. As of
oped in Taiwan, combined with growth opportunities in bancas- February 26, 2008, $54 billion in notional exposures have either
surance and variable annuities with living benefits, may potentially been terminated or are in the process of being terminated. AIGFP
create a need for capital contributions in 2008 and beyond to was not required to make any payments as part of these
support local solvency requirements. terminations and in certain cases was paid a fee upon termina-
tion. In light of this experience to date and after other comprehen-
sive analyses, AIG did not recognize an unrealized market
Financial Services
valuation adjustment for this regulatory capital relief portfolio for
Within Financial Services, demand for International Lease Finance the year ended December 31, 2007. AIG will continue to assess
Corporation (ILFC’s) modern, fuel efficient aircraft remains strong, the valuation of this portfolio and monitor developments in the
and ILFC plans to increase its fleet by purchasing 73 aircraft in marketplace. There can be no assurance that AIG will not
2008. However, ILFC’s margins may be adversely affected by recognize unrealized market valuation losses from this portfolio in
increases in interest rates. AIG Financial Products Corp. and AIG future periods. These transactions contributed approximately
Trading Group Inc. and their respective subsidiaries (collectively, $210 million to AIGFP’s revenues in 2007. If AIGFP is not
AIGFP) expect opportunities for growth across their product successful in replacing the revenues generated by these transac-
segments, but AIGFP is a transaction-oriented business, and its tions, AIGFP’s operating results could be materially adversely
operating results will depend to a significant extent on actual affected. For additional information on the AIGFP super senior
transaction flow, which is affected by market conditions and other credit default swap portfolio, see Risk Management — Segment
variables outside its control. AIG continues to explore opportuni- Risk Management — Financial Services — Capital Markets Deriva-
ties to expand its Consumer Finance operations into new tive Transactions and Note 8 to Consolidated Financial
domestic and foreign markets. Statements.
The ongoing disruption in the U.S. residential mortgage and In March 2007, the U.S. Treasury Department published
credit markets and the recent downgrades of residential mortgage- proposed regulations that, had they been adopted in 2007, would
backed securities and CDO securities by rating agencies continue have had the effect of limiting the ability of AIG to claim foreign
to adversely affect the fair value of the super senior credit default tax credits with respect to certain transactions entered into by
swap portfolio written by AIGFP. AIG expects that continuing AIGFP. AIGFP is no longer a participant in those transactions and
limitations on the availability of market observable data will affect therefore, the proposed regulations, if adopted in their current
AIG’s determinations of the fair value of these derivatives, form in 2008 or subsequent years, would not be expected to have
including by preventing AIG, for the foreseeable future, from any material effect on AIG’s ability to claim foreign tax credits.
recognizing the beneficial effect of the differential between credit Effective January 1, 2008, AIGFP elected to apply the fair
spreads used to price a credit default swap and spreads implied value option to all eligible assets and liabilities, other than equity
from prices of the CDO bonds referenced by such swap. The fair method investments. The adoption of FAS 159 with respect to
value of these derivatives is expected to continue to fluctuate, elections made by AIGFP is currently being evaluated for the effect
perhaps materially, in response to changing market conditions, of recently issued draft guidance by the FASB, anticipated to be
and AIG’s estimates of the value of AIGFP’s super senior credit issued in final form in early 2008, and its potential effect on
derivative portfolio at future dates could therefore be materially AIG’s consolidated financial statements.
different from current estimates. AIG continues to believe that the
unrealized market valuation losses recorded on the AIGFP super Asset Management
senior credit default swap portfolio are not indicative of the losses
AIGFP may realize over time. Under the terms of most of these In the Spread-Based Investment business, the Guaranteed Invest-
credit derivatives, losses to AIG would generally result from the ment Contract (GIC) portfolio continues to run off and was
credit impairment of the referenced CDO bonds that AIG would replaced by the Matched Investment Program (MIP). The results
acquire in satisfying its swap obligations. Based upon its most from domestic GICs and the MIP have been adversely affected by
current analyses, AIG believes that any credit impairment losses the ongoing disruption in the credit markets, the weakening
realized over time by AIGFP will not be material to AIG’s U.S. dollar and declining interest rates. The MIP is exposed to
consolidated financial condition, although it is possible that such credit and market risk in the form of investments in, among other
realized losses could be material to AIG’s consolidated results of asset classes, U.S. residential mortgage-backed securities, asset-
operations for an individual reporting period. Except to the extent backed securities, commercial mortgage-backed securities and
of any such credit impairment losses, AIG expects the unrealized single name corporate credit default swaps entered into by the
market valuation losses to reverse over the remaining life of the MIP. In addition, earnings volatility for the MIP may arise from
super senior credit default swap portfolio. investments in bank loans that are held for future collateralized
Approximately $379 billion of the $527 billion in notional loan obligations to be managed by AIG Investments. The value of
exposure on AIGFP’s super senior credit default swap portfolio as the investments may fluctuate materially from period to period due
of December 31, 2007 were written to facilitate regulatory capital to market movements, which may result in realized and unrealized
relief for financial institutions primarily in Europe. AIG expects that net losses. Although it is difficult to estimate future movements in
the majority of these transactions will be terminated within the these markets, effective hedges exist to mitigate the effect of
AIG 2007 Form 10-K 33