AIG 2012 Annual Report Download - page 210

.....................................................................................................................................................................................
The following paragraphs describe the methods we use to measure fair value on a recurring basis for certain classes
of assets and liabilities classified in Level 3. See Note 6 to the Consolidated Financial Statements for discussion of
the valuation methodologies for other assets classified in Level 3, including certain fixed maturity securities and
certain other invested assets, as well as discussion of transfers of Level 3 assets and liabilities.
Super Senior Credit Default Swap Portfolio
..............................................................................................................................................................................................
The entities included in GCM wrote credit protection on the super senior risk layer of collateralized loan obligations
(CLOs), multi-sector CDOs and diversified portfolios of corporate debt, and prime residential mortgages through
2006. In these transactions, AIG is at risk of credit performance on the super senior risk layer related to such assets.
To a lesser extent, those entities also wrote protection on tranches below the super senior risk layer, primarily related
to regulatory capital relief transactions.
See Notes 6 and 12 to the Consolidated Financial Statements for information about the Regulatory Capital, Multi-
Sector CDO, Corporate Debt/Collateralized Debt Obligation (CLO) and other portfolios.
AIG utilizes sensitivity analyses that estimate the effects of using alternative pricing and other key inputs on our
calculation of the unrealized market valuation loss related to the super senior credit default swap portfolio. While we
believe that the ranges used in these analyses are reasonable, we are unable to predict which of the scenarios is
most likely to occur. As recent experience demonstrates, actual results in any period are likely to vary, perhaps
materially, from the modeled scenarios, and there can be no assurance that the unrealized market valuation loss
related to the super senior credit default swap portfolio will be consistent with any of the sensitivity analyses. On
average, prices for CDOs increased during 2012. Further, it is difficult to extrapolate future experience based on
current market conditions.
For the purposes of estimating sensitivities for the super senior multi-sector CDO credit default swap portfolio, the
change in valuation derived using the Binomial Expansion Technique (BET) model is used to estimate the change in
the fair value of the derivative liability. Of the total $3.9 billion net notional amount of CDS written on multi-sector
CDOs outstanding at December 31, 2012, a BET value is available for $2.6 billion net notional amount. No BET
value is determined for $1.3 billion of CDS written on European multi-sector CDOs as prices on the underlying
securities held by the CDOs are not provided by collateral managers; instead these CDS are valued using
counterparty prices. Therefore, sensitivities disclosed below apply only to the net notional amount of $2.6 billion.
The most significant assumption used in the BET model is the estimated price of the securities within the CDO
collateral pools. If the actual price of the securities within the collateral pools differs from the price used in estimating
the fair value of the super senior credit default swap portfolio, there is potential for material variation in the fair value
estimate. Any declines in the value of the underlying collateral securities held by a CDO will similarly affect the value
of the super senior CDO securities. While the models attempt to predict changes in the prices of underlying collateral
securities held within a CDO, the changes are subject to actual market conditions which have proved to be highly
volatile. We cannot predict reasonably likely changes in the prices of the underlying collateral securities held within a
CDO at this time.
..................................................................................................................................................................................................................................
AIG 2012 Form 10-K 193
ITEM 7 / CRITICAL ACCOUNTING ESTIMATES