AIG 2009 Annual Report Download - page 185

American International Group, Inc., and Subsidiaries
The CRC reviews quarterly concentration reports in all categories listed above as well as credit trends by risk
ratings. The CRC may adjust limits to provide reasonable assurance that AIG does not incur excessive levels of credit
risk and that AIG’s credit risk profile is properly calibrated across business units.
Market Risk Management
AIG is exposed to market risks, primarily within its insurance and capital markets businesses (see Capital Resources
and Liquidity — AIG’s Strategy for Stabilization and Repayment of its Obligations as They Come Due — AIGFP
Wind-down regarding its market risk issues and management as transactions in that business are wound down). For
AIG’s insurance operations, the asset-liability exposures are predominantly structural in nature, and not the result of
speculative positioning to take advantage of short-term market opportunities. For example, the business model of life
insurance and retirement savings is to collect premiums or deposits from policyholders and invest the proceeds in
predominantly long-term, credit based assets. A spread is earned over time between the asset yield and the cost
payable to policyholders. The asset and liability profiles are managed so that the cash flows resulting from invested
assets are sufficient to meet policyholder obligations when they become due without the need to sell assets
prematurely into a potentially distressed market. In periods of severe market volatility, depressed and illiquid market
values on otherwise performing investments diminish shareholders’ equity even without the realization of actual credit
event related losses. Such diminution of capital strength has caused downward pressure on the market’s assessment of
the financial strength and the credit ratings of insurers.
The Market Risk Management and Independent Valuation function (MRMIV), which reports to the CRO, is
responsible for control and oversight of all frequently traded market risks within AIG. The Insurance Risk
Management function (IRM), which also reports to the CRO, is responsible for control and oversight of
non-frequently traded asset liability management risks and risk aggregation across AIG’s financial services, insurance,
and investment activities.
AIG’s market exposures can be categorized as follows:
•Benchmark interest rates. Benchmark interest rates are also known as risk-free interest rates and are associated
with either the government / treasury yield curve or the swap curve. The fair value of AIG’s significant fixed
maturity securities portfolio changes as benchmark interest rates change.
•Credit spread or risk premium. Credit spread risk is the potential for loss due to a change in an instrument’s risk
premium or yield relative to that of a comparable-duration, default-free instrument.
•Equity and alternative investment prices. AIG’s exposure to equity and alternative investment prices arises from
direct investments in common stocks and mutual funds, from minimum benefit guarantees embedded in the
structure of certain variable annuity and variable life insurance products and from other equity-like investments,
such as partnerships comprised of hedge funds and private equity funds, private equity investments, commercial
real estate and real estate funds.
•Foreign currency exchange rates. AIG is a globally diversified enterprise with significant income, assets and
liabilities denominated in, and significant capital deployed in, a variety of currencies.
AIG uses a number of measures and approaches to measure and quantify its market risk exposure, including:
•Duration / key rate duration. Duration is the measure of the sensitivities of a fixed-income instrument to the
parallel shift in the benchmark yield curve. Key rate duration measures sensitivities to the movement at a given
term point on the yield curve.
•Scenario analysis. Scenario analysis uses historical, hypothetical, or forward-looking macro-economic scenarios
to assess and report exposures. Examples of hypothetical scenarios include a 100 basis point parallel shift in the
yield curve or a 10 percent immediate and simultaneous decrease in world-wide equity markets.
177 AIG 2009 Form 10-K