AIG 2008 Annual Report Download - page 162

products. Difficult market conditions in recent quarters have significantly hindered AIG’s ability to achieve these
objectives, and these challenges are expected to persist for the foreseeable future.
At the local operating unit level, investment strategies are based on considerations that include the local
market, liability duration and cash flow characteristics, rating agency and regulatory capital considerations, legal
investment limitations, tax optimization and diversification.
The majority of assets backing insurance liabilities at AIG consist of intermediate and long duration fixed
maturity securities. In the case of Life Insurance & Retirement Services companies, as well as in the GIC and MIP
portfolios of the Asset Management segment, the fundamental investment strategy is, as nearly as is practicable, to
match the duration characteristics of the liabilities with comparable duration assets. Fixed maturity securities held
by the insurance companies included in the AIG Property Casualty Group historically have consisted primarily of
laddered holdings of tax-exempt municipal bonds, which provided attractive after-tax returns and limited credit
risk. In light of AIG’s net operating position, AIG changed its intent to hold to maturity certain tax-exempt
municipal securities held by its insurance subsidiaries. Fixed maturity securities held by Foreign General Insurance
companies consist primarily of intermediate duration high grade securities.
The market price of fixed maturity securities reflects numerous components, including interest rate envi-
ronment, credit spread, embedded optionality (such as call features), liquidity, structural complexity, foreign
exchange risk, and other credit and non-credit factors. However, in most circumstances, pricing is most sensitive to
interest rates, such that the market price declines as interest rates rise, and increases as interest rates fall. This effect
is more pronounced for longer duration securities.
AIG marks to market the vast majority of the invested assets held by its insurance companies pursuant to
FAS 115, “Accounting for Certain Investments in Debt and Equity Securities,” and related accounting pronounce-
ments. However, with limited exceptions (primarily with respect to separate account products consolidated on
AIG’s balance sheet pursuant to SOP 03-01), AIG does not mark-to-market its insurance liabilities for changes in
interest rates, even though rising interest rates have the effect of reducing the fair value of such liabilities, and falling
interest rates have the opposite effect. This results in the recording of changes in unrealized gains (losses) on
securities in Accumulated other comprehensive income resulting from changes in interest rates without any
correlative, inverse changes in gains (losses) on AIG’s liabilities. Because AIG’s asset duration in certain low-yield
currencies, particularly Japan and Taiwan, is shorter than its liability duration, AIG views increasing interest rates in
these countries as economically advantageous, notwithstanding the effect that higher rates have on the market value
of its fixed maturity portfolio.
Discussion of investments by operating segment is as follows:
General Insurance
In AIG’s General Insurance business, the duration of liabilities for long-tail casualty lines is greater than other
lines. As differentiated from the Life Insurance & Retirement Services companies, the focus is not on asset-liability
matching, but on preservation of capital and growth of surplus.
Fixed income holdings of the AIG Property Casualty Group are currently comprised primarily of tax-exempt
securities, which provide attractive risk-adjusted after-tax returns. These high quality municipal investments have
an average rating of AA.
Fixed income assets held in Foreign General Insurance are of high quality and short to intermediate duration,
averaging 2.5 years compared to 6.9 years for those in AIG Property Casualty Group.
While invested assets backing reserves are invested in conventional fixed income securities in AIG Property
Casualty Group, a modest portion of surplus is allocated to large capitalization, high-dividend, public equity
strategies and to alternative investments, including private equity and hedge funds. Notwithstanding the current
environment, these investments have provided a combination of added diversification and attractive long-term
returns over time.
156 AIG 2008 Form 10-K
American International Group, Inc., and Subsidiaries