AIG 2012 Annual Report Download - page 255

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on the underlying securities. This data is then aggregated and used to estimate the expected cash flows of the super
senior tranche of the CDO.
Prices for the individual securities held by a CDO are obtained in most cases from the CDO collateral managers, to
the extent available. CDO collateral managers provided market prices for 59 percent of the underlying securities used
in the valuation at December 31, 2012. When a price for an individual security is not provided by a CDO collateral
manager, we derive the price through a pricing matrix using prices from CDO collateral managers for similar
securities. Matrix pricing is a mathematical technique used principally to value debt securities without relying
exclusively on quoted prices for the specific securities, but rather by relying on the relationship of the security to
other benchmark quoted securities. Substantially all of the CDO collateral managers who provided prices used dealer
prices for all or part of the underlying securities, in some cases supplemented by third-party pricing services.
The BET model also uses diversity scores, weighted average lives, recovery rates and discount rates. We employ a
Monte Carlo simulation to assist in quantifying the effect on the valuation of the CDO of the unique aspects of the
CDO’s structure such as triggers that divert cash flows to the most senior part of the capital structure. The Monte
Carlo simulation is used to determine whether an underlying security defaults in a given simulation scenario and, if it
does, the security’s implied random default time and expected loss. This information is used to project cash flow
streams and to determine the expected losses of the portfolio.
In addition to calculating an estimate of the fair value of the super senior CDO security referenced in the credit
default swaps using our internal model, we also consider the price estimates for the super senior CDO securities
provided by third parties, including counterparties to these transactions, to validate the results of the model and to
determine the best available estimate of fair value. In determining the fair value of the super senior CDO security
referenced in the credit default swaps, we use a consistent process that considers all available pricing data points
and eliminates the use of outlying data points. When pricing data points are within a reasonable range an averaging
technique is applied.
In the case of credit default swaps written on
portfolios of investment-grade corporate debt, we use a mathematical model that produces results that are closely
aligned with prices received from third parties. This methodology uses the current market credit spreads of the
names in the portfolios along with the base correlations implied by the current market prices of comparable tranches
of the relevant market traded credit indices as inputs.
We estimate the fair value of our obligations resulting from credit default swaps written on CLOs to be equivalent to
the par value less the current market value of the referenced obligation. Accordingly, the value is determined by
obtaining third-party quotations on the underlying super senior tranches referenced under the credit default swap
contract.
Policyholder Contract Deposits
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Policyholder contract deposits accounted for at fair value are measured using an earnings approach by taking into
consideration the following factors:
• Current policyholder account values and related surrender charges;
• The present value of estimated future cash inflows (policy fees) and outflows (benefits and maintenance expenses)
associated with the product using risk neutral valuations, incorporating expectations about policyholder behavior,
market returns and other factors; and
• A risk margin that market participants would require for a market return and the uncertainty inherent in the model
inputs.
The change in fair value of these policyholder contract deposits is recorded as Policyholder benefits and claims
incurred in the Consolidated Statement of Operations.
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AIG 2012 Form 10-K238
Corporate debt/Collateralized loan obligation (CLO) portfolios:
ITEM 8 / NOTE 6. FAIR VALUE MEASUREMENTS