AIG 2010 Annual Report Download - page 165

American International Group, Inc., and Subsidiaries
See also Investments herein for further information.
The CRC reviews quarterly concentration reports in all categories listed above as well as credit trends by risk
ratings. The CRC periodically adjusts 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 — Financial Services — Capital Markets 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.
AIG 2010 Form 10-K 149