AIG 2010 Annual Report Download - page 187

American International Group, Inc., and Subsidiaries
the fair value measurement in its entirety. 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. Assets and liabilities measured at fair value on a recurring basis and classified as Level 3
include certain RMBS, CMBS and collateralized debt obligations/asset-backed securities (CDO/ABS), corporate
debt, certain municipal and sovereign debt, certain derivative contracts (including Capital Markets’ super senior
credit default swap portfolio), policyholder contract deposits carried at fair value, private equity and real estate
fund investments, and direct private equity investments. AIG’s non-financial instrument assets that are measured
at fair value on a non-recurring basis generally are classified as Level 3.
Refer to Note 6 to the Consolidated Financial Statements for discussion of transfers of Level 3 assets and
liabilities.
Valuation of Level 3 Assets and Liabilities
AIG values its assets and liabilities classified as Level 3 using judgment and valuation models or other pricing
techniques that require a variety of inputs including contractual terms, market prices and rates, yield curves, credit
curves, measures of volatility, prepayment rates and correlations of such inputs, some of which may be
unobservable. The following paragraphs describe the methods AIG uses to measure on a recurring basis the fair
value of the major classes of assets and liabilities classified in Level 3.
Private equity and real estate fund investments and certain hedge fund investments: These assets initially are
valued at the transaction price, i.e., the price paid to acquire the asset. Subsequently, they are measured based on
net asset value using information provided by the general partner or manager of these investments, the accounts
of which generally are audited on an annual basis. AIG considers observable market data and performs diligence
procedures in validating the appropriateness of using the net asset value as a fair value measurement.
Certain corporate bonds and private placement debt: These assets initially are valued at the transaction price.
Subsequently, they are valued using market data for similar instruments (e.g., recent transactions, bond spreads or
credit default swap spreads). When observable price quotations are not available, fair value is determined based
on cash flow models using yield curves observed from indices or credit default swap spreads.
Certain RMBS and CMBS: These assets initially are valued at the transaction price. Subsequently, they may be
valued by comparison to transactions in instruments with similar collateral and risk profiles considering
remittances received and updated cumulative loss data on underlying obligations, or discounted cash flow
techniques.
Certain ABS — non-mortgage: These assets initially are valued at the transaction price. Subsequently, they may
be valued based on external price/spread data. When position-specific external price data are not observable, the
valuation is based on prices of comparable securities.
CDOs: These assets initially are valued at the transaction price. Subsequently, they are valued based on
external price/spread data from independent third parties, dealer quotations, matrix pricing, the Binomial
Expansion Technique (BET) model or a combination of these methods.
Interests in the Maiden Lane Interests: At their inception, ML II and ML III were valued at the transaction
prices of $1 billion and $5 billion, respectively. Subsequently, Maiden Lane Interests are valued using a discounted
cash flow methodology that uses the estimated future cash flows of the assets to which the Maiden Lane Interests
are entitled and the discount rates applicable to such interests as derived from the fair value of the entire asset
pool. The implicit discount rates are calibrated to the changes in the estimated asset values for the underlying
assets commensurate with AIG’s interests in the capital structure of the respective entities. Estimated cash flows
and discount rates used in the valuations are validated, to the extent possible, using market observable information
for securities with similar asset pools, structure and terms.
The fair value methodology used assumes that the underlying collateral in the Maiden Lane Interests will
continue to be held and generate cash flows into the foreseeable future and does not assume a current liquidation
AIG 2010 Form 10-K 171