AIG 2014 Annual Report Download - page 192

ITEM 7 / ENTERPRISE RISK MANAGEMENT
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impacted by a number of factors including changes in market conditions, tax law, regulations and policyholder preferences.
This risk exists in the majority of our product lines.
• Interest rate risk - represents the potential for loss due to a change in interest rates. Interest rate risk is measured with
respect to assets, liabilities (both insurance-related and financial), and derivatives. This risk manifests itself when interest
rates move significantly in a short period of time (interest rate shock) but can also manifest itself over a longer period of time
such as a persistent low interest rate environment.
• Equity risk – represents the potential for loss due to changes in equity prices. It affects equity-linked insurance products,
including but not limited to index annuities, variable annuities (and associated guaranteed living and death benefits),
universal life insurance, and variable universal life insurance. It also affects our equity 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.
Other Operations Risks
Global Capital Markets
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 and operational 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.
GCM Derivative Transactions
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 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 transaction 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 enforceable netting agreement exists, the fair value of the transaction with the
counterparty represents the net sum of estimated fair values.
The fair value of GCM’s interest rate, currency, credit, commodity and equity swaps, options, swaptions, and forward
commitments, futures, and forward contracts reported in Derivative assets, at fair value, was approximately $1.4 billion at both
December 31, 2014 and 2013. Where applicable, these amounts have been determined in accordance with the respective
master netting agreements.
GCM evaluates counterparty credit quality by internal analysis consistent with the risk rating policies of ERM, and supplements
such analysis with ratings from rating agencies, where applicable. In addition, GCM’s credit approval process involves pre-
approved counterparty credit exposure limits that are established by ERM.