AIG 2008 Annual Report Download - page 156

The decrease in the weighted average prices reflects continued deterioration in the markets for RMBS and
CMBS and further downgrades in RMBS and CMBS credit ratings.
Prices for the individual securities held by a CDO are obtained in most cases from the CDO collateral
managers, to the extent available. For the year ended December 31, 2008, CDO collateral managers provided
market prices for 61.2 percent of the underlying securities. When a price for an individual security is not provided
by a CDO collateral manager, AIGFP derives the price through a pricing matrix using prices from CDO collateral
managers for similar securities. Matrix pricing is a mathematical technique used principally to value debt securities
without relying exclusively on quoted prices for the specific securities, but rather by relying on the relationship of
the security to other benchmark-quoted securities. Substantially all of the CDO collateral managers who provided
prices used dealer prices for all or part of the underlying securities, in some cases supplemented by third-party
pricing services.
The BET model also uses diversity scores, weighted average lives, recovery rates and discount rates. The
determination of some of these inputs requires the use of judgment and estimates, particularly in the absence of
market-observable data. Diversity scores (which reflect default correlations between the underlying securities of a
CDO) are obtained from CDO trustees or implied from default correlations. Weighted average lives of the
underlying securities are obtained, when available, from external subscription services such as Bloomberg and Intex
and, if not available, AIGFP utilizes an estimate reflecting known weighted average lives.
Collateral recovery rates are obtained from the multi-sector CDO recovery data of a major rating agency.
AIGFP utilizes a LIBOR-based interest rate curve to derive its discount rates.
AIGFP employs similar control processes to validate these model inputs as those used to value AIG’s
investment portfolio as described in Critical Accounting Estimates — Fair Value Measurements of Certain
Financial Assets and Liabilities — Overview. The effects of the adjustments resulting from the validation process
were de minimis for each period presented.
Valuation Sensitivity — Arbitrage Portfolio
Multi-Sector CDOs
AIG utilizes sensitivity analyses that estimate the effects of using alternative pricing and other key inputs on
AIG’s calculation of the unrealized market valuation loss related to the AIGFP super senior credit default swap
portfolio. While AIG believes that the ranges used in these analyses are reasonable, given the current difficult
market conditions, AIG is unable to predict which of the scenarios is most likely to occur. As recent experience
demonstrates, actual results in any period are likely to vary, perhaps materially, from the modeled scenarios, and
there can be no assurance that the unrealized market valuation loss related to the AIGFP super senior credit default
swap portfolio will be consistent with any of the sensitivity analyses. On average for any quarterly period during the
past year, prices for CDOs declined between 6.14 percent and 11.93 percent of the notional amount outstanding.
Further, it is difficult to extrapolate future experience based on current dislocated market conditions.
For the purposes of estimating sensitivities for the super senior multi-sector CDO credit default swap portfolio,
the change in valuation derived using the BET model is used to estimate the change in the fair value of the derivative
liability. Out of the total $12.6 billion net notional amount of CDS written on multi-sector CDOs outstanding at
December 31, 2008, a BET value is available for $8.8 billion net notional amount. No BET value is determined for
$3.8 billion of CDS written on European multi-sector CDOs as prices on the underlying securities held by the CDOs
are not provided by collateral managers; instead these CDS are valued using counterparty prices. Therefore,
sensitivities disclosed below apply only to the net notional amount of $8.8 billion.
As mentioned above, the most significant assumption used in the BET model is the estimated price of the
securities within the CDO collateral pools. If the actual price of the securities within the collateral pools differs from
the price used in estimating the fair value of the super senior credit default swap portfolio, there is potential for
material variation in the fair value estimate. Any further declines in the value of the underlying collateral securities
held by a CDO will similarly affect the value of the super senior CDO securities given their significantly depressed
valuations. Given the current difficult market conditions, AIG cannot predict reasonably likely changes in the prices
of the underlying collateral securities held within a CDO at this time.
150 AIG 2008 Form 10-K
American International Group, Inc., and Subsidiaries