AIG 2014 Annual Report Download - page 181

ITEM 7 / ENTERPRISE RISK MANAGEMENT
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Interest rates. Interest rate risk can arise from a mismatch in the interest rate exposure of assets versus liabilities. Lower
interest rates generally result in lower investment income and resulting product changes will generally reduce the
attractiveness of our insurance products in the marketplace. Conversely, higher interest rates are typically beneficial for the
opposite reasons. However, when rates rise quickly, there can be a temporary asymmetric U.S. GAAP accounting effect where
the existing securities lose market value, which is largely reported in Other comprehensive income, and the offsetting decrease
in the value of related liabilities may not be recognized. Changes in interest rates can affect the valuation of fixed maturity
securities, financial liabilities, insurance contracts including but not limited to fixed rate annuities, variable annuities and
derivative contracts.
Credit spreads. Credit spreads measure an instrument’s risk premium or yield relative to that of a comparable duration,
default-free instrument. Changes in credit spreads can affect the valuation of fixed maturity securities, including but not limited
to corporate bonds, asset-backed securities, mortgage-backed securities, AIG-issued debt obligations, credit derivatives and
derivative credit valuation adjustments. Much like higher interest rates, wider credit spreads mean more investment income in
the long-term. In the short term, quickly rising spreads will cause a loss in the value of existing fixed maturity securities, which
is largely reported in Other comprehensive income. A precipitous rise in credit spreads may also signal a fundamental
weakness in the credit-worthiness of bond obligors, potentially resulting in default losses.
Foreign exchange (FX) rates. We are a globally diversified enterprise with significant income, assets and liabilities
denominated in, and significant capital deployed in, a variety of currencies. Changes in FX rates can affect the valuation of a
broad range of balance sheet and income statement items as well as the settlement of cash flows exchanged in specific
transactions.
Commodity Prices. Changes in commodity prices (the value of commodities) can affect the valuation of publicly-traded
commodities, commodity indices and derivatives on commodities and commodity indices.
Inflation. Changes in inflation can affect the valuation of fixed maturity securities, including AIG-issued debt obligations,
derivatives and other contracts explicitly linked to inflation indices, and insurance contracts where the claims are linked to
inflation either explicitly, via indexing, or implicitly, through medical costs or wage levels.
Governance
Market risk is managed at the corporate level within ERM through the CMRO, who reports directly to the AIG CRO. The
CMRO is supported by a dedicated team of professionals within ERM who work in partnership with the senior management of
our finance, treasury and investment management corporate functions. The CMRO is primarily responsible for the
development and maintenance of a risk management framework that includes the following key components:
• written policies that define the rules for our market risk-taking activities and provide clear guidance regarding their execution
and management;
• a limit framework that aligns with our Board-approved Risk Appetite Statement;
• independent measurement, monitoring and reporting for line of business, business unit and enterprise-wide market risks;
and
• clearly defined authorities for all individuals and committee roles and responsibilities related to market risk management.
These components facilitate the CMRO’s identification, measurement, monitoring, reporting and management of our market
risks.
Risk Measurement
Our market risk measurement framework was developed with the main objective of communicating the range and scale of our
market risk exposures. At the firm-wide level market risk is measured in a manner that is consistent with AIG’s Risk Appetite
Statement. This is designed to ensure that we remain within our stated risk tolerance levels and can determine how much
additional market risk taking capacity is available within our framework. Our risk appetite is currently defined in terms of capital