AIG 2010 Annual Report Download - page 313

American International Group, Inc., and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Collateral
Most of AIGFP’s super senior credit default swaps are subject to collateral posting provisions, which typically
are governed by International Swaps and Derivatives Association, Inc. (ISDA) Master Agreements (Master
Agreements) and related Credit Support Annexes (CSA). These provisions differ among counterparties and asset
classes. AIGFP has received collateral calls from counterparties in respect of certain super senior credit default
swaps, of which a large majority relate to multi-sector CDOs. To a lesser extent, AIGFP has also received
collateral calls in respect of certain super senior credit default swaps entered into by counterparties for regulatory
capital relief purposes and in respect of corporate arbitrage.
The amount of future collateral posting requirements is a function of AIG’s credit ratings, the rating of the
reference obligations and 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.
At December 31, 2010 and December 31, 2009, the amounts of collateral postings with respect to AIGFP’s
super senior credit default swap portfolio (prior to offsets for other transactions) were $3.8 billion and $4.6 billion,
respectively.
AIGFP Written Single Name Credit Default Swaps
AIGFP has also entered into credit default swap contracts referencing single-name exposures written on
corporate, index and asset-backed credits, with the intention of earning spread income on credit exposure. Some
of these transactions were entered into as part of a long-short strategy allowing AIGFP to earn the net spread
between CDS it wrote and ones it purchased. At December 31, 2010, the net notional amount of these written
CDS contracts was $377 million. AIGFP has hedged these exposures by purchasing offsetting CDS contracts of
$188 million in net notional amount. The net unhedged position of approximately $189 million represents the
maximum exposure to loss on these CDS contracts. The average maturity of the written CDS contracts is
13.36 years. At December 31, 2010, the fair value of derivative liability (which represents the carrying value) of the
portfolio of CDS was $9 million.
Upon a triggering event (e.g., a default) with respect to the underlying credit, AIGFP would normally have the
option to settle the position through an auction process (cash settlement) or pay the notional amount of the
contract to the counterparty in exchange for a bond issued by the underlying credit obligor (physical settlement).
AIGFP wrote these written CDS contracts under Master Agreements. The majority of these Master Agreements
include CSA, which provide for collateral postings at various ratings and threshold levels. At December 31, 2010,
AIGFP had posted $21 million of collateral under these contracts.
All Other Derivatives
AIG’s non-Capital Markets businesses also use derivatives and other instruments as part of their financial risk
management programs. Interest rate derivatives (such as interest rate swaps) are used to manage interest rate risk
associated with investments in fixed income securities, outstanding medium- and long-term notes and other
interest rate sensitive assets and liabilities. In addition, foreign exchange derivatives (principally foreign exchange
forwards and options) are used to economically mitigate risk associated with non-U.S. dollar denominated debt,
net capital exposures and foreign exchange transactions. The derivatives are effective economic hedges of the
exposures they are meant to offset.
AIG 2010 Form 10-K 297