AIG 2010 Annual Report Download - page 262

American International Group, Inc., and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fair Value Hierarchy
Assets and liabilities recorded at fair value in the Consolidated Balance Sheet are measured and classified in a
hierarchy for disclosure purposes consisting of three ‘‘levels’’ based on the observability of inputs available in the
marketplace used to measure the fair values as discussed below:
•Level 1: Fair value measurements that are quoted prices (unadjusted) in active markets that AIG has the
ability to access for identical assets or liabilities. Market price data generally is obtained from exchange or
dealer markets. AIG does not adjust the quoted price for such instruments. Assets and liabilities measured
at fair value on a recurring basis and classified as Level 1 include certain government and agency securities,
actively traded listed common stocks and futures and options contracts, most separate account assets and
most mutual funds.
•Level 2: Fair value measurements based on inputs other than quoted prices included in Level 1, that are
observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for
similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for
the asset or liability, such as interest rates and yield curves that are observable at commonly quoted
intervals. Assets and liabilities measured at fair value on a recurring basis and classified as Level 2 generally
include certain government and agency securities, most investment-grade and high-yield corporate bonds,
certain residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS) and
collateralized loan obligations/asset backed securities (CLO/ABS), certain listed equities, state, municipal and
provincial obligations, hybrid securities, securities purchased (sold) under agreements to resell (repurchase),
mutual fund and hedge fund investments, certain interest rate, currency and commodity derivative contracts,
guaranteed investment agreements (GIAs) for the Direct Investment business, other long-term debt and
physical commodities.
•Level 3: Fair value measurements based on valuation techniques that use significant inputs that are
unobservable. Both observable and unobservable inputs may be used to determine the fair values of
positions classified in Level 3. These measurements include circumstances in which there is little, if any,
market activity for the asset or liability. Therefore, AIG must make certain assumptions as to the inputs a
hypothetical market participant would use to value that asset or liability. In certain cases, the inputs used to
measure 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 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.
The following is a description of the valuation methodologies used for instruments carried at fair value. These
methodologies are applied to assets and liabilities across the levels noted above, and it is the observability of the
inputs used that determines the appropriate level in the fair value hierarchy for the respective asset or liability.
Valuation Methodologies
Incorporation of Credit Risk in Fair Value Measurements
•AIG’s Own Credit Risk. Fair value measurements for certain Direct Investment business’ debt, GIAs,
structured note liabilities and freestanding derivatives, as well as Capital Markets derivatives, incorporate
246 AIG 2010 Form 10-K