AIG 2010 Annual Report Download - page 204

American International Group, Inc., and Subsidiaries
amount of collateral required to be posted by AIGFP in connection with such instruments, have resulted in
estimates that differ, at times significantly, from AIGFP’s estimates. In almost all cases, AIGFP has been able to
successfully resolve the differences or otherwise reach an accommodation with respect to collateral posting levels,
including in certain cases by entering into compromise collateral arrangements. Due to the ongoing nature of
collateral arrangements, AIGFP regularly is engaged in discussions with one or more counterparties in respect of
these differences, including at the present time. Valuation estimates made by counterparties for collateral purposes
are, like any other third-party valuation, considered in the determination of the fair value estimates of the Capital
Markets super senior credit default swap portfolio.
The following table presents the amount of collateral postings with respect to the Capital Markets super senior
credit default swap portfolio (prior to offsets for other transactions) as of the periods ended:
(in millions) December 31, 2009 December 31, 2010 February 16, 2011
Regulatory capital $ 310 $ 236 $ 226
Arbitrage – multi-sector CDO 3,715 3,013 2,843
Arbitrage – corporate 565 537 527
Total $ 4,590 $ 3,786 $ 3,596
The amount of future collateral posting requirements generally is a function of AIG’s credit ratings, the rating
of the reference obligations and any further decline in the market value of the relevant reference obligations, with
the latter being the most significant factor. While a high level of correlation exists between the amount of
collateral posted and the valuation of these contracts in respect of the arbitrage portfolio, a similar relationship
does not exist with respect to the regulatory capital portfolio given the nature of how the amount of collateral for
these transactions is determined. Given the lack of observable data and the uncertainty regarding the potential
effects on market prices of measures undertaken by the federal government to address the credit market
disruption, AIGFP is unable to reasonably estimate the amounts of collateral that it may be required to post in
the future.
Models and Modeling
AIGFP values its credit default swaps written on the super senior risk layers of designated pools of debt
securities or loans using internal valuation models, third-party price estimates and market indices. The principal
market was determined to be the market in which super senior credit default swaps of this type and size would be
transacted, or have been transacted, with the greatest volume or level of activity. AIG has determined that the
principal market participants, therefore, would consist of other large financial institutions who participate in
sophisticated over-the-counter derivatives markets. The specific valuation methodologies vary based on the nature
of the referenced obligations and availability of market prices.
The valuation of the super senior credit derivatives continues to be challenging given the limitation on the
availability of market observable information due to the lack of trading and price transparency in the structured
finance market. These market conditions have increased the reliance on management estimates and judgments in
arriving at an estimate of fair value for financial reporting purposes. Further, disparities in the valuation
methodologies employed by market participants and the varying judgments reached by such participants when
assessing volatile markets have increased the likelihood that the various parties to these instruments may arrive at
significantly different estimates as to their fair values.
AIGFP’s valuation methodologies for the super senior credit default swap portfolio have evolved in response to
the deteriorating market conditions and the lack of sufficient market observable information. AIG regularly
calibrates the model to available market information and reviews model assumptions on a regular basis.
188 AIG 2010 Form 10-K