AIG 2014 Annual Report Download - page 248

ITEM 8 / NOTE 5. FAIR VALUE MEASUREMENTS
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credit risk by using discount rates that take into consideration cash issuance spreads for similar instruments or other
observable information.
The cost of credit protection is determined under a discounted present value approach considering the market levels for single
name CDS spreads for each specific counterparty, the mid market value of the net exposure (reflecting the amount of
protection required) and the weighted average life of the net exposure. CDS spreads are provided to us by an independent
third party. We utilize an interest rate based on the benchmark London Interbank Offered Rate (LIBOR) curve to derive our
discount rates.
While this approach does not explicitly consider all potential future behavior of the derivative transactions or potential future
changes in valuation inputs, we believe this approach provides a reasonable estimate of the fair value of the assets and
liabilities, including consideration of the impact of non-performance risk.
Fixed Maturity Securities
Whenever available, we obtain quoted prices in active markets for identical assets at the balance sheet date to measure fixed
maturity securities at fair value. Market price data is generally obtained from dealer markets.
We employ independent third-party valuation service providers to gather, analyze, and interpret market information to derive
fair value estimates for individual investments, based upon market-accepted methodologies and assumptions. The
methodologies used by these independent third-party valuation service providers are reviewed and understood by
management, through periodic discussion with and information provided by the independent third-party valuation service
providers. In addition, as discussed further below, control processes are applied to the fair values received from independent
third-party valuation service providers to ensure the accuracy of these values.
Valuation service providers typically obtain data about market transactions and other key valuation model inputs from multiple
sources and, through the use of market-accepted valuation methodologies, which may utilize matrix pricing, financial models,
accompanying model inputs and various assumptions, provide a single fair value measurement for individual securities. The
inputs used by the valuation service providers include, but are not limited to, market prices from completed transactions for
identical securities and transactions for comparable securities, benchmark yields, interest rate yield curves, credit spreads,
prepayment rates, default rates, currency rates, quoted prices for similar securities and other market-observable information,
as applicable. If fair value is determined using financial models, these models generally take into account, among other things,
market observable information as of the measurement date as well as the specific attributes of the security being valued,
including its term, interest rate, credit rating, industry sector, and when applicable, collateral quality and other security or
issuer-specific information. When market transactions or other market observable data is limited, the extent to which judgment
is applied in determining fair value is greatly increased.
We have control processes designed to ensure that the fair values received from independent third-party valuation service
providers are accurately recorded, that their data inputs and valuation techniques are appropriate and consistently applied and
that the assumptions used appear reasonable and consistent with the objective of determining fair value. We assess the
reasonableness of individual security values received from independent third-party valuation service providers through various
analytical techniques, and have procedures to escalate related questions internally and to the independent third-party
valuation service providers for resolution. To assess the degree of pricing consensus among various valuation service
providers for specific asset types, we conduct comparisons of prices received from available sources. We use these
comparisons to establish a hierarchy for the fair values received from independent third-party valuation service providers to be
used for particular security classes. We also validate prices for selected securities through reviews by members of
management who have relevant expertise and who are independent of those charged with executing investing transactions.
When our independent third-party valuation service providers are unable to obtain sufficient market observable information
upon which to estimate the fair value for a particular security, fair value is determined either by requesting brokers who are
knowledgeable about these securities to provide a price quote, which is generally non-binding, or by employing market
accepted valuation models. Broker prices may be based on an income approach, which converts expected future cash flows to
a single present value amount, with specific consideration of inputs relevant to particular security types. For structured
securities, such inputs may include ratings, collateral types, geographic concentrations, underlying loan vintages, loan
delinquencies and defaults, prepayments, and weighted average coupons and maturities. When the volume or level of market