AIG 2015 Annual Report Download - page 175

ITEM 7 / ENTERPRISE RISK MANAGEMENT
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Risk Identification
Market risk focuses on quantifying the financial repercussions of changes in broad, external, predominantly market observable
risks. Financial repercussions can include an adverse impact on results of operations, financial condition, liquidity and capital.
Each of the following systemic risks is considered a market risk:
Equity prices. We are exposed to changes in equity market prices affecting a variety of instruments. Changes in equity prices
can affect the valuation of publicly-traded equity shares, investments in private equity, hedge funds and mutual funds,
exchange-traded funds, and other equity-linked capital market instruments as well as equity-linked insurance products,
including but not limited to index annuities, variable annuities, universal life insurance and variable universal life insurance.
Residential and commercial real estate values. Our investment portfolios are exposed to the risk of changing values in a
variety of residential and commercial real estate investments. Changes in residential/commercial real estate prices can affect
the valuation of residential/commercial mortgages, residential/commercial mortgage-backed securities and other structured
securities with underlying assets that include residential/commercial mortgages: trusts that include residential/commercial real
estate and/or mortgages, residential mortgage insurance contracts and commercial real estate investments.
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 make certain of our product offerings less attractive to investors.
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, ABS, mortgage-backed securities, AIG-issued debt obligations, credit derivatives and derivative credit
valuation adjustments. Much like higher interest rates, wider credit spreads with unchanged default losses 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. We are exposed to commodity
prices primarily through their impact on the prices and credit quality of commodity producers’ debt and equity securities in our
investment portfolio.
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 overseen 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. Market Risk is managed by our finance, treasury and