AIG 2009 Annual Report Download - page 255

American International Group, Inc., and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Both observable and unobservable inputs may be used to determine the fair values of positions classified in Level 3
in the tables above. As a result, the unrealized gains (losses) on instruments held at December 31, 2009 and 2008 may
include changes in fair value that were attributable to both observable (e.g., changes in market interest rates) and
unobservable inputs (e.g., changes in unobservable long-dated volatilities).
AIG’s policy is to transfer assets and liabilities into Level 3 when a significant input cannot be corroborated with
market observable data. This may include: circumstances in which market activity has dramatically decreased and
transparency to underlying inputs cannot be observed, current prices are not available, and substantial price variances
in quotations among market participants exist.
In certain cases, the inputs used to measure the fair value may fall into different levels of the fair value hierarchy. In
such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is
determined based on the lowest level input that is significant to the fair value measurement. AIG’s assessment of the
significance of a particular input to the fair value measurement in its entirety requires judgment. In making the
assessment, AIG considers factors specific to the asset or liability.
During the year ended December 31, 2009, AIG transferred into Level 3 approximately $9.6 billion of assets,
consisting of certain ABS, CMBS and RMBS, as well as private placement corporate debt. A majority of the transfers
into Level 3 related to investments in ABS, RMBS and CMBS and was due to a decrease in market transparency and
downward credit migration in these securities. Transfers into Level 3 for private placement corporate debt are
primarily the result of AIG over-riding third party matrix pricing information downward to better reflect the
additional risk premium associated with those securities that AIG believes was not captured in the matrix.
Assets are transferred out of Level 3 when circumstances change such that significant inputs can be corroborated
with market observable data. This may be due to a significant increase in market activity for the asset, a specific event,
one or more significant input(s) becoming observable, or when a long-term interest rate significant to a valuation
becomes short-term and thus observable. During the year ended December 31, 2009, AIG transferred approximately
$5.8 billion of assets out of Level 3. These transfers out of Level 3 are primarily related to investments in certain ABS
and RMBS and investments in private placement corporate debt. Transfers out of Level 3 for ABS and RMBS
investments were primarily due to increased usage of pricing from valuation service providers that were reflective of
market activity, where previously an internally adjusted price had been used. Transfers out of Level 3 for private
placement corporate debt were primarily the result of AIG using observable pricing information or a third party
pricing quote that appropriately reflects the fair value of those securities, without the need for adjustment based on
AIG’s own assumptions regarding the characteristics of a specific security or the current liquidity in the market.
During the year ended December 31, 2009, AIG transferred into Level 3 approximately $816.4 million of liabilities,
related to derivatives and certain notes payable. A majority of the transfers out of Level 3 liabilities, which totaled
$316.0 million, were due to recognition of the cash flow variability on interest rate and cross currency swaps with
securitization vehicles. Other transfers, both into and out of Level 3 liabilities, were due to movement in market
variables.
AIG uses various hedging techniques to manage risks associated with certain positions, including those classified
within Level 3. Such techniques may include the purchase or sale of financial instruments that are classified within
Level 1 and/or Level 2. As a result, the realized and unrealized gains (losses) for assets and liabilities classified within
Level 3 presented in the table above do not reflect the related realized or unrealized gains (losses) on hedging
instruments that are classified within Level 1 and/or Level 2.
247 AIG 2009 Form 10-K