AIG 2009 Annual Report Download - page 250

American International Group, Inc., and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
valuations to third-party prices and made adjustments as necessary to determine the best available estimate of fair
value. During the third quarter of 2009, AIGFP enhanced its valuation methodology for credit default swaps written
on portfolios of investment-grade corporate debt. This new methodology uses a mathematical model that produces
results that are more closely aligned with prices received from third-parties. This methodology is widely used by other
market participants and uses the current market credit spreads of the names in the portfolios along with the base
correlations implied by the current market prices of comparable tranches of the relevant market traded credit indices
as inputs. Two transactions, representing two percent of the total notional amount of the corporate arbitrage
transactions, are valued using third party quotes given their unique attributes.
AIGFP estimates the fair value of its obligations resulting from credit default swaps written on CLOs to be
equivalent to the par value less the current market value of the referenced obligation. Accordingly, the value is
determined by obtaining third-party quotes on the underlying super senior tranches referenced under the credit
default swap contract.
Policyholder Contract Deposits
Policyholder contract deposits accounted for at fair value are measured using an earnings approach by taking into
consideration the following factors:
• Current policyholder account values and related surrender charges;
• The present value of estimated future cash inflows (policy fees) and outflows (benefits and maintenance
expenses) associated with the product using risk neutral valuations, incorporating expectations about
policyholder behavior, market returns and other factors; and
• A risk margin that market participants would require for a market return and the uncertainty inherent in the
model inputs.
The change in fair value of these policyholder contract deposits is recorded as Policyholder benefits and claims
incurred in the Consolidated Statement of Income (Loss).
Securities and spot commodities sold but not yet purchased
Fair values for securities sold but not yet purchased are based on current market prices. Fair values of spot
commodities sold but not yet purchased are based on current market prices of reference spot futures contracts traded
on exchanges.
Other long-term debt
When fair value accounting has been elected, the fair value of non-structured liabilities is generally determined by
using market prices from exchange or dealer markets, when available, or discounting expected cash flows using the
appropriate discount rate for the applicable maturity. The discount rate is based on an implicit rate determined with
the use of observable CDS market spreads to determine the risk of non-performance for AIG. Such instruments are
generally classified in Level 2 of the fair value hierarchy as substantially all inputs are readily observable. AIG
determines the fair value of structured liabilities (where performance is linked to structured interest rates, inflation or
currency risks) and hybrid financial instruments (performance linked to risks other than interest rates, inflation or
currency risks) using the appropriate derivative valuation methodology (described above) given the nature of the
embedded risk profile. Such instruments are classified in Level 2 or Level 3 depending on the observability of
significant inputs to the model. In addition, adjustments are made to the valuations of both non-structured and
structured liabilities to reflect AIG’s own credit worthiness based on observable credit spreads of AIG.
AIG 2009 Form 10-K 242