AIG 2014 Annual Report Download - page 293

ITEM 8 / NOTE 11. DERIVATIVES AND HEDGE ACCOUNTING
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derivatives contained in insurance contract liabilities, fixed maturity securities, outstanding medium- and long-term notes as
well as other interest rate sensitive assets and liabilities. Foreign exchange derivatives (principally foreign exchange forwards
and options) are used to economically mitigate risk associated with non-U.S. dollar denominated debt, net capital exposures,
and foreign currency transactions. Equity derivatives are used to mitigate financial risk embedded in certain insurance
liabilities. The derivatives are effective economic hedges of the exposures that they are meant to offset.
In addition to hedging activities, we also enter into derivative instruments with respect to investment operations, which include,
among other things, credit default swaps and purchasing investments with embedded derivatives, such as equity-linked notes
and convertible bonds.
Credit Risk-Related Contingent Features
The aggregate fair value of our derivative instruments that contain credit risk-related contingent features that were in a net
liability position at December 31, 2014 and 2013, was approximately $2.5 billion and $2.6 billion, respectively. The aggregate
fair value of assets posted as collateral under these contracts at December 31, 2014 and 2013, was $2.7 billion and $3.1
billion, respectively.
We estimate that at December 31, 2014, based on our outstanding financial derivative transactions, a one-notch downgrade of
our long-term senior debt ratings to BBB+ by Standard & Poor’s Financial Services LLC, a subsidiary of The McGraw-Hill
Companies, Inc. (S&P), would permit counterparties to make additional collateral calls and permit certain counterparties to
elect early termination of contracts, resulting in a negligible amount of corresponding collateral postings and termination
payments; a one-notch downgrade to Baa2 by Moody’s Investors’ Service, Inc. (Moody’s) and an additional one-notch
downgrade to BBB by S&P would result in approximately $46 million in additional collateral postings and termination
payments, and a further one-notch downgrade to Baa3 by Moody’s and BBB- by S&P would result in approximately
$153 million in additional collateral postings and termination payments.
Additional collateral postings upon downgrade are estimated based on the factors in the individual collateral posting provisions
of the CSA with each counterparty and current exposure as of December 31, 2014. Factors considered in estimating the
termination payments upon downgrade include current market conditions, the complexity of the derivative transactions,
historical termination experience and other observable market events such as bankruptcy and downgrade events that have
occurred at other companies. Our estimates are also based on the assumption that counterparties will terminate based on their
net exposure to us. The actual termination payments could significantly differ from our estimates given market conditions at the
time of downgrade and the level of uncertainty in estimating both the number of counterparties who may elect to exercise their
right to terminate and the payment that may be triggered in connection with any such exercise.
Hybrid Securities with Embedded Credit Derivatives
We invest in hybrid securities (such as credit-linked notes) with the intent of generating income, and not specifically to acquire
exposure to embedded derivative risk. As is the case with our other investments in RMBS, CMBS, CDOs and ABS, our
investments in these hybrid securities are exposed to losses only up to the amount of our initial investment in the hybrid
security. Other than our initial investment in the hybrid securities, we have no further obligation to make payments on the
embedded credit derivatives in the related hybrid securities.
We elect to account for our investments in these hybrid securities with embedded written credit derivatives at fair value, with
changes in fair value recognized in Net investment income and Other income. Our investments in these hybrid securities are
reported as Other bond securities in the Consolidated Balance Sheets. The fair values of these hybrid securities were
$6.1 billion and $6.4 billion at December 31, 2014 and 2013, respectively. These securities have par amounts of $12.3 billion
and $13.4 billion at December 31, 2014 and 2013, respectively, and both have remaining stated maturity dates that extend to
2052.