AIG 2009 Annual Report Download - page 156

American International Group, Inc., and Subsidiaries
almost all cases, AIGFP has been able to successfully resolve the differences or otherwise reach an accommodation
with respect to collateral posting levels, including in certain cases by entering into compromise collateral
arrangements. Due to the ongoing nature of these collateral calls, AIGFP may engage in discussions with one or more
counterparties in respect of these differences at any time. Valuation estimates made by counterparties for collateral
purposes are, like any other third-party valuation, considered in the determination of the fair value estimates of
AIGFP’s super senior credit default swap portfolio.
The following table presents the amount of collateral postings with respect to AIGFP’s super senior credit default swap
portfolio (prior to offsets for other transactions) as of the periods ended:
(in millions) December 31, 2008 December 31, 2009 February 17, 2010
Regulatory capital $ 1,287 $ 310 $ 286
Arbitrage — multi-sector CDO 5,129 3,715 3,714
Arbitrage — corporate 2,349 565 582
Total $ 8,765 $ 4,590 $ 4,582
The amount of future collateral posting requirements is a function of AIG’s credit ratings, the rating of the
reference obligations and any further decline in the market value of the relevant reference obligations, with the latter
being the most significant factor. While a high level of correlation exists between the amount of collateral posted and
the valuation of these contracts in respect of the arbitrage portfolio, a similar relationship does not exist with respect
to the regulatory capital portfolio given the nature of how the amount of collateral for these transactions is
determined. Given the severe market disruption, lack of observable data and the uncertainty regarding the potential
effects on market prices of measures recently undertaken by the federal government to address the credit market
disruption, AIGFP is unable to reasonably estimate the amounts of collateral that it may be required to post in the
future.
Models and Modeling
AIGFP values its credit default swaps written on the super senior risk layers of designated pools of debt securities
or loans using internal valuation models, third-party price estimates and market indices. The principal market was
determined to be the market in which super senior credit default swaps of this type and size would be transacted, or
have been transacted, with the greatest volume or level of activity. AIG has determined that the principal market
participants, therefore, would consist of other large financial institutions who participate in sophisticated
over-the-counter derivatives markets. The specific valuation methodologies vary based on the nature of the referenced
obligations and availability of market prices.
The valuation of the super senior credit derivatives continues to be challenging given the limitation on the
availability of market observable information due to the lack of trading and price transparency in the structured
finance market, particularly during and since the second half of 2007. These market conditions have increased the
reliance on management estimates and judgments in arriving at an estimate of fair value for financial reporting
purposes. Further, disparities in the valuation methodologies employed by market participants and the varying
judgments reached by such participants when assessing volatile markets have increased the likelihood that the various
parties to these instruments may arrive at significantly different estimates as to their fair values.
AIGFP’s valuation methodologies for the super senior credit default swap portfolio have evolved in response to the
deteriorating market conditions and the lack of sufficient market observable information. AIG regularly calibrates the
model to available market information and reviews model assumptions on a regular basis.
Arbitrage Portfolio — Multi-Sector CDOs
The underlying assumption of the valuation methodology for AIGFP’s credit default swap portfolio wrapping multi-
sector CDOs is that, to be willing to assume the obligations under a credit default swap, a market participant would
AIG 2009 Form 10-K 148