AIG 2013 Annual Report Download - page 194

investments and equity-related investments. In addition, changes in the volatility of equity prices can affect the
valuation of those insurance products that are accounted for in a manner similar to equity derivatives.
AIG Life and Retirement manages these risks through product design, experience monitoring, pricing actions, risk
limitations, reinsurance and active monitoring and management of the relationships between assets and liabilities,
including hedging. The emergence of significant adverse experience would require an adjustment to DAC and benefit
reserves which could have a material adverse effect on our consolidated results of operations for a particular period.
For a further discussion of this risk, see Item 1A. Risk Factors — Business and Operations.
For UGC, risks emanate primarily from the following:
•Mortgage Underwriting risk — represents the potential exposure to loss due to borrower default on a first-lien
residential mortgage; the primary drivers of this risk are home price depreciation, changes in the unemployment
rate, changes in mortgage rates, and a borrower’s willingness to pay.
•Pricing risk — represents the potential exposure to loss if actual policy experience emerges adversely in
comparison to the assumptions made in product pricing. This may be related to adverse economic conditions,
prepayment of policies, investment results, and expenses.
UGC manages the quality of the loans it insures through use of a proprietary risk quality index. UGC uses this index
to determine an insurability threshold as well as to manage the risk distribution of its new business. Along with
traditional mortgage underwriting variables, UGC’s risk-based pricing model uses rating factors such as geography
and the historical quality of a lender’s origination process to establish premium rates.
UGC’s risk appetite framework establishes various concentration limits on the business UGC insures (for example,
geography), and defines underwriting characteristics for which UGC will not insure loans.
GCM actively manages its exposures to limit potential economic losses, and in doing so, GCM must continually
manage a variety of exposures including credit, market, liquidity, operational and legal risks. The senior management
of AIG defines the policies and establishes general operating parameters for GCM’s operations. Our senior
management has established various oversight committees to regularly monitor various financial market, operational
and credit risks related to GCM’s operations. The senior management of GCM reports the results of its operations to
and reviews future strategies with AIG’s senior management.
A counterparty may default on any obligation to us, including a derivative contract. Credit risk is a consequence of
extending credit and/or carrying trading and investment positions. Credit risk exists for a derivative contract when that
contract has a positive fair value to AIG. The maximum potential exposure will increase or decrease during the life of
the derivative commitments as a function of maturity and market conditions. To help manage this risk, GCM’s credit
department operates within the guidelines set by the credit function within ERM. Transactions that fall outside these
pre-established guidelines require the specific approval of ERM. It is also AIG’s policy to record credit valuation
adjustments for potential counterparty default when necessary.
In addition, GCM utilizes various credit enhancements, including letters of credit, guarantees, collateral, credit
triggers, credit derivatives, margin agreements and subordination to reduce the credit risk relating to its outstanding
financial derivative transactions. GCM requires credit enhancements in connection with specific transactions based
on, among other things, the creditworthiness of the counterparties, and the transaction’s size and maturity.
Furthermore, GCM enters into certain agreements that have the benefit of set-off and close-out netting provisions;
such as ISDA Master Agreements, repurchase agreements and securities lending agreements. These provisions
provide that, in the case of an early termination of a transaction, GCM can set off its receivables from a counterparty
against its payables to the same counterparty arising out of all covered transactions. As a result, where a legally
Mortgage Guaranty Key Insurance Risks
Other Operations Risks
Global Capital Markets
GCM Derivative Transactions
..................................................................................................................................................................................................................................
AIG 2013 Form 10-K176
ITEM 7 / ENTERPRISE RISK MANAGEMENT
..................................................................................................................................................................................
............................................................................................................................................................................................
............................................................................................................................................................................................
............................................................................................................................................................................................
............................................................................................................................................................................................