AIG 2010 Annual Report Download - page 314

American International Group, Inc., and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In addition to hedging activities, AIG also uses derivative instruments with respect to investment operations,
which include, among other things, credit default swaps and purchasing investments with embedded derivatives,
such as equity linked notes and convertible bonds.
Matched Investment Program Written Credit Default Swaps
AIG’s Matched Investment Program (MIP) operations, which are reported in AIG’s Other operations category
as part of Asset Management — Direct Investment business, are currently in run-off. Through the MIP, AIG has
entered into CDS contracts as a writer of protection, with the intention of earning spread income on credit
exposure in an unfunded form. The portfolio of CDS contracts were single-name exposures and, at inception, were
predominantly high-grade corporate credits.
These contracts were written through AIG Markets, which then transacted directly with unaffiliated third parties
under ISDA agreements. As of December 31, 2010, the notional amount of written CDS contracts was $1.9 billion
with an average credit rating of BBB+. At that date, the average maturity of the written CDS contracts was
1.2 years and the fair value of the derivative liability (which represents the carrying value) of the MIP’s written
CDS was $25.4 million.
The majority of the ISDA agreements include CSA provisions, which provide for collateral postings at various
ratings and threshold levels. At December 31, 2010, $1.8 million of collateral was posted for CDS contracts related
to the MIP. The notional amount represents the maximum exposure to loss on the written CDS contracts.
However, because of the average investment grade rating and expected default recovery rates, actual losses are
expected to be less.
Upon a triggering event (e.g., a default) with respect to the underlying credit, AIG Markets would normally
have the option to settle the position on behalf of the MIP 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
(physical settlement).
Credit Risk-Related Contingent Features
AIG transacts in derivative transactions directly with unaffiliated third parties under ISDA agreements. Many of
the ISDA agreements also include CSA provisions, which provide for collateral postings at various ratings and
threshold levels. In addition, AIG attempts to reduce credit risk with certain counterparties by entering into
agreements that enable collateral to be obtained from a counterparty on an upfront or contingent basis.
The aggregate fair value of AIG’s derivative instruments, including those of AIGFP, that contain credit
risk-related contingent features that were in a net liability position at December 31, 2010, was approximately
$5.2 billion. The aggregate fair value of assets posted as collateral under these contracts at December 31, 2010,
was $5.2 billion. See Note 6 herein.
AIG estimates that at December 31, 2010, based on AIG’s outstanding financial derivative transactions,
including those of AIGFP at that date, a one-notch downgrade of AIG’s long-term senior debt ratings to Baa1 by
Moody’s Investors Service (Moody’s) and BBB+ by Standard & Poor’s Financial Services LLC, a subsidiary of
The McGraw-Hill Companies, Inc. (S&P), would permit counterparties to make additional collateral calls and
permit the counterparties to elect early termination of contracts, resulting in up to approximately $0.7 billion of
corresponding collateral postings and termination payments; a two-notch downgrade to Baa2 by Moody’s and BBB
by S&P would result in approximately $0.4 billion in additional collateral postings and termination payments above
the one-notch downgrade amount; and a three-notch downgrade to Baa3 by Moody’s and BBB- by S&P would
result in approximately $0.2 billion in additional collateral postings and termination payments above the two-notch
downgrade amount. Additional collateral postings upon downgrade are estimated based on the factors in the
individual collateral posting provisions of the CSA with each counterparty and current exposure as of
December 31, 2010. Factors considered in estimating the termination payments upon downgrade include current
298 AIG 2010 Form 10-K