AIG 2009 Annual Report Download - page 154

American International Group, Inc., and Subsidiaries
In general, each party has the right under a CSA to act as the ‘‘Valuation Agent’’ and initiate the calculation of the
exposure of one party to the other (Exposure) in respect of transactions covered by the CSA. The valuation
calculation may be performed daily, weekly or at some other interval, and the frequency is one of the terms negotiated
at the time the CSA is signed. The definition of Exposure under a standard CSA is the amount that would be payable
to one party by the other party upon a hypothetical termination of that transaction. This amount is determined, in
most cases, by the Valuation Agent using its estimate of mid-market quotations (i.e., the average of hypothetical bid
and ask quotations) of the amounts that would be paid for a replacement transaction. AIGFP determines Exposure
typically by reference to the mark-to-market valuation of the relevant transaction produced by its systems and
specialized models. Exposure amounts are typically determined for all transactions under a Master Agreement (unless
the parties have specifically agreed to exclude certain transactions, not to apply the CSA or to set a specific
transaction Exposure to zero). The aggregate Exposure less the value of collateral already held by the relevant party
(and following application of certain thresholds) results in a net exposure amount (Delivery Amount). If this amount
is a positive number, then the other party must deliver collateral with a value equal to the Delivery Amount. Under
the standard CSA, the party not acting as Valuation Agent for any particular Exposure calculation may dispute the
Valuation Agent’s calculation of the Delivery Amount. If the parties are unable to resolve this dispute, the terms of
the standard CSA provide that the Valuation Agent is required to recalculate Exposure using, in substitution for the
disputed Exposure amounts, the average of actual quotations at mid-market from four leading dealers in the relevant
market.
After an Exposure amount is determined for a transaction subject to a CSA, it is combined with the Exposure
amounts for all other transactions under the relevant Master Agreement, which may be netted against one another
where the counterparties to a Master Agreement are each exposed to one another in respect of different transactions.
Actual collateral postings with respect to a Master Agreement may be affected by other agreed CSA terms, including
threshold and independent amounts, that may increase or decrease the amount of collateral posted.
Regulatory Capital Relief Transactions
As of December 31, 2009, 52.8 percent of AIGFP’s regulatory capital relief transactions (measured by net notional
amount) were subject to a CSA linked to AIG’s credit rating and 47.2 percent of the regulatory capital relief
transactions were not subject to collateral posting provisions. In general, each regulatory capital relief transaction is
subject to a stand-alone Master Agreement or similar agreement, under which the aggregate Exposure is calculated
with reference to only a single transaction.
The underlying mechanism that determines the amount of collateral to be posted varies by counterparty, and there
is no standard formula. The varied mechanisms resulted from individual negotiations with different counterparties.
The following is a brief description of the primary mechanisms that are currently being employed to determine the
amount of collateral posting for this portfolio.
Reference to Market Indices—Under this mechanism, the amount of collateral to be posted is determined based on a
formula that references certain tranches of a market index, such as either iTraxx or CDX. This mechanism is used
for CDS transactions that reference either corporate loans, or residential mortgages. While the market index is not
a direct proxy, it has the advantage of being readily obtainable.
Market Value of Reference Obligation—Under this mechanism the amount of collateral to be posted is determined
based on the difference between the net notional amount of a referenced RMBS security and the security’s market
value.
Expected Loss Models—Under this mechanism, the amount of collateral to be posted is determined based on the
amount of expected credit losses, generally determined using a rating-agency model.
Negotiated Amount—Under this mechanism, the amount of collateral to be posted is determined based on terms
negotiated between AIGFP and the counterparty, which could be a fixed percentage of the notional amount or
present value of premiums to be earned by AIGFP.
AIG 2009 Form 10-K 146