AIG 2008 Annual Report Download - page 191

Pandemic Flu, the analysis indicates AIG could incur a pre-tax loss of approximately $0.6 billion if this event were
to recur. The analyses were based on 2007 policy data representing approximately 95 percent of AIG’s individual
life, group life and credit life books of business, net of reinsurance at that point in time. This estimate does not
include claims that could be made under other policies, such as business interruption or general liability policies,
and does not reflect estimates for losses resulting from disruption of AIG’s own business operations or asset losses
that may arise out of such a pandemic. The model used to generate these estimates has been developed only recently.
The reasonableness of the model and its underlying assumptions cannot readily be verified by reference to
comparable historical events. As a result, AIG’s actual losses from a pandemic influenza outbreak are likely to vary
significantly from those predicted by the model.
Financial Services
AIG’s Financial Services subsidiaries engage in diversified activities including aircraft leasing, capital
markets, consumer finance and insurance premium finance. Together, the Aircraft Leasing, Capital Markets
and Consumer Finance operations generate the majority of the revenues produced by the Financial Services
operations. A.I. Credit also contributes to Financial Services income principally by providing insurance premium
financing for both AIG’s policyholders and those of other insurers.
Capital Markets
Capital Markets represents the operations of AIGFP, which engaged as principal in a wide variety of financial
transactions, including standard and customized financial products involving commodities, credit, currencies,
energy, equities and interest rates. AIGFP also invested in a diversified portfolio of securities and principal
investments and engaged in borrowing activities that involve issuing standard and structured notes and other
securities and entering into GIAs. Given the extreme market conditions experienced in 2008, downgrades of AIG’s
credit ratings by the rating agencies, as well as because of AIG’s intent to refocus on its core businesses, AIGFP has
begun to unwind its businesses and portfolios.
The senior management of AIG defines the policies and establishes general operating parameters for Capital
Markets operations. AIG’s senior management has established various 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 reports the results of its operations to and reviews future strategies with AIG’s
senior management.
AIGFP actively manages its exposures to limit potential economic losses, and in doing so, AIGFP must
continually manage a variety of exposures including credit, market, liquidity, operational and legal risks.
Derivative Transactions
A counterparty may default on any obligation to AIG, including a derivative contract. Credit risk is a
consequence of extending credit and/or carrying trading and investment positions. Credit risk exists for a derivative
contract when that contract has a positive fair value to AIG. The maximum potential exposure will increase or
decrease during the life of the derivative commitments as a function of maturity and market conditions. To help
manage this risk, AIGFP’s credit department operates within the guidelines set by the CRC. Transactions which fall
outside these pre-established guidelines require the specific approval of the CRC. It is also AIG’s policy to establish
reserves for potential credit impairment when necessary.
In addition, AIGFP utilizes various credit enhancements, including letters of credit, guarantees, collateral,
credit triggers, credit derivatives and margin agreements to reduce the credit risk relating to its outstanding financial
derivative transactions. AIGFP requires credit enhancements in connection with specific transactions based on,
among other things, the creditworthiness of the counterparties, and the transaction’s size and maturity. Furthermore,
AIGFP generally seeks to enter into agreements that have the benefit of set-off and close-out netting provisions.
These provisions provide that, in the case of an early termination of a transaction, AIGFP can set off its receivables
from a counterparty against its payables to the same counterparty arising out of all covered transactions. As a result,
where a legally enforceable netting agreement exists, the fair value of the transaction with the counterparty
represents the net sum of estimated fair values. The fair value of AIGFP’s interest rate, currency, commodity and
equity swaps, options, swaptions, and forward commitments, futures, and forward contracts approximated
AIG 2008 Form 10-K 185
American International Group, Inc., and Subsidiaries