AIG 2008 Annual Report Download - page 135

See Note 4 to the Consolidated Financial Statements for more detailed information about AIG’s accounting
policy for the incorporation of credit risk in fair value measurements and the measurement of fair value of the
following financial assets and financial liabilities:
• Fixed maturity securities;
• Equity securities traded in active markets — trading and available for sale;
• Non-traded equity investments — other invested assets;
• Private limited partnership and hedge fund investments — other invested assets;
• Separate account assets;
• Freestanding derivatives;
• Embedded policy derivatives;
• AIGFP’s super senior credit default swap portfolio; and
• Policyholder contract deposits.
Level 3 Assets and Liabilities
Under FAS 157, assets and liabilities recorded at fair value in the consolidated balance sheet are classified in a
hierarchy for disclosure purposes consisting of three “levels” based on the observability of inputs available in the
marketplace used to measure the fair value. See Note 4 to the Consolidated Financial Statements for additional
information about fair value measurements.
At December 31, 2008, AIG classified $42.1 billion and $21.1 billion of assets and liabilities, respectively,
measured at fair value on a recurring basis as Level 3. This represented 4.9 percent and 2.6 percent of the total assets
and liabilities, respectively, measured at fair value on a recurring basis. Level 3 fair value measurements are based
on valuation techniques that use at least one significant input that is unobservable. These measurements are made
under circumstances in which there is little, if any, market activity for the asset or liability. AIG’s assessment of the
significance of a particular input to the fair value measurement in its entirety requires judgment.
In making the assessment, AIG considers factors specific to the asset or liability. In certain cases, the inputs
used to measure fair value of an asset or a liability may fall into different levels of the fair value hierarchy. In such
cases, the level in the fair value hierarchy within which the fair value measurement in its entirety is classified is
determined based on the lowest level input that is significant to the fair value measurement in its entirety.
Valuation of Level 3 Assets and Liabilities
AIG values its assets and liabilities classified as Level 3 using judgment and valuation models or other pricing
techniques that require a variety of inputs including contractual terms, market prices and rates, yield curves, credit
curves, measures of volatility, prepayment rates and correlations of such inputs, some of which may be unob-
servable. The following paragraphs describe the methods AIG uses to measure on a recurring basis the fair value of
the major classes of assets and liabilities classified in Level 3.
Private equity and real estate fund investments: These assets initially are valued at the transaction price, i.e.,
the price paid to acquire the asset. Subsequently, they are measured based on net asset value using information
provided by the general partner or manager of these investments, the accounts of which generally are audited on an
annual basis. AIG considers observable market data and performs diligence procedures in validating the appro-
priateness of using the net asset value as a fair value measurement.
Corporate bonds and private placement debt: These assets initially are valued at the transaction price.
Subsequently, they are valued using market data for similar instruments (e.g., recent transactions, bond spreads or
credit default swap spreads), comparisons to benchmark derivative indices or movements in underlying credit
spreads. When observable price quotations are not available, fair value is determined based on cash flow models
with yield curves, bond or single-name credit default swap spreads and estimated recovery rates.
AIG 2008 Form 10-K 129
American International Group, Inc., and Subsidiaries