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FAIR VALUE MEASUREMENTS
 12 Months Ended
Dec. 31, 2012
FAIR VALUE MEASUREMENTS  
FAIR VALUE MEASUREMENTS

6. FAIR VALUE MEASUREMENTS

 

 

Fair Value Measurements on a Recurring Basis

 

We carry certain of our financial instruments at fair value. We define the fair value of a financial instrument as the amount that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We are responsible for the determination of the value of the investments carried at fair value and the supporting methodologies and assumptions.

The degree of judgment used in measuring the fair value of financial instruments generally inversely correlates with the level of observable valuation inputs. We maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Financial instruments with quoted prices in active markets generally have more pricing observability and less judgment is used in measuring fair value. Conversely, financial instruments for which no quoted prices are available have less observability and are measured at fair value using valuation models or other pricing techniques that require more judgment. Pricing observability is affected by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established, the characteristics specific to the transaction, liquidity and general market conditions.

Fair Value Hierarchy

 

Assets and liabilities recorded at fair value in the Consolidated Balance Sheet are measured and classified in accordance with a fair value hierarchy consisting of three "levels" based on the observability of inputs available in the marketplace used to measure the fair values as discussed below:

•
Level 1:  Fair value measurements that are quoted prices (unadjusted) in active markets that we have the ability to access for identical assets or liabilities. Market price data generally is obtained from exchange or dealer markets. We do not adjust the quoted price for such instruments.

•
Level 2:  Fair value measurements based on inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.
•
Level 3:  Fair value measurements based on valuation techniques that use significant inputs that are unobservable. Both observable and unobservable inputs may be used to determine the fair values of positions classified in Level 3. The circumstances for using these measurements include those in which there is little, if any, market activity for the asset or liability. Therefore, we must make certain assumptions as to the inputs a hypothetical market participant would use to value that asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety.

The following is a description of the valuation methodologies used for instruments carried at fair value. These methodologies are applied to assets and liabilities across the levels noted above, and it is the observability of the inputs used that determines the appropriate level in the fair value hierarchy for the respective asset or liability.

 

Valuation Methodologies of Financial Instruments Measured at Fair Value

 

Incorporation of Credit Risk in Fair Value Measurements

 

•
Our Own Credit Risk.  Fair value measurements for certain liabilities incorporate our own credit risk by determining the explicit cost for each counterparty to protect against its net credit exposure to us at the balance sheet date by reference to observable AIG CDS or cash bond spreads. A derivative counterparty's net credit exposure to us is determined based on master netting agreements, when applicable, which take into consideration all derivative positions with us, as well as collateral we post with the counterparty at the balance sheet date. We calculate the effect of these credit spread changes using discounted cash flow techniques that incorporate current market interest rates.

•
Counterparty Credit Risk.  Fair value measurements for freestanding derivatives incorporate counterparty credit by determining the explicit cost for us to protect against our net credit exposure to each counterparty at the balance sheet date by reference to observable counterparty CDS spreads, when available. When not available, other directly or indirectly observable credit spreads will be used to derive the best estimates of the counterparty spreads. Our net credit exposure to a counterparty is determined based on master netting agreements, which take into consideration all derivative positions with the counterparty, as well as collateral posted by the counterparty at the balance sheet date.

Fair values for fixed maturity securities based on observable market prices for identical or similar instruments implicitly incorporate counterparty credit risk. Fair values for fixed maturity securities based on internal models incorporate counterparty 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 – Trading and Available for Sale

 

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 in our trading and available for sale portfolios. 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 services are reviewed and understood by management, through periodic discussion with and information provided by the valuation services. In addition, as discussed further below, control processes are applied to the fair values received from third-party valuation services 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 widely 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, 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 third party valuation services 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 valuation service providers through various analytical techniques, and have procedures to escalate related questions internally and to the third party valuation services for resolution. To assess the degree of pricing consensus among various valuation services for specific asset types, we have conducted comparisons of prices received from available sources. We have used these comparisons to establish a hierarchy for the fair values received from third party valuation services 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 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 widely 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 weighted average coupons and maturities. When the volume or level of market activity for a security is limited, certain inputs used to determine fair value may not be observable in the market. Broker prices may also be based on a market approach that considers recent transactions involving identical or similar securities. Fair values provided by brokers are subject to similar control processes to those noted above for fair values from third party valuation services, including management reviews. For those corporate debt instruments (for example, private placements) that are not traded in active markets or that are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and non-transferability, and such adjustments generally are based on available market evidence. When observable price quotations are not available, fair value is determined based on discounted cash flow models using discount rates based on credit spreads, yields or price levels of comparable securities, adjusted for illiquidity and structure. Fair values determined internally are also subject to management review to ensure that valuation models and related inputs are reasonable.

The methodology above is relevant for all fixed maturity securities including residential mortgage-backed securities (RMBS), commercial mortgage backed securities (CMBS), CDOs, other asset-backed securities (ABS) and fixed maturity securities issued by government sponsored entities and corporate entities.

Equity Securities Traded in Active Markets – Trading and Available for Sale

 

Whenever available, we obtain quoted prices in active markets for identical assets at the balance sheet date to measure at fair value marketable equity securities in our trading and available for sale portfolios or in Other invested assets. Market price data is generally obtained from exchange or dealer markets.

Mortgage and Other Loans Receivable

 

We estimate the fair value of mortgage and other loans receivable that are measured at fair value by using dealer quotations, discounted cash flow analyses and/or internal valuation models. The determination of fair value considers inputs such as interest rate, maturity, the borrower's creditworthiness, collateral, subordination, guarantees, past-due status, yield curves, credit curves, prepayment rates, market pricing for comparable loans and other relevant factors.

Other Invested Assets

 

We initially estimate the fair value of investments in certain hedge funds, private equity funds and other investment partnerships by reference to the transaction price. Subsequently, we generally obtain the fair value of these investments from net asset value information provided by the general partner or manager of the investments, the financial statements of which are generally audited annually. We consider observable market data and perform certain control procedures to validate the appropriateness of using the net asset value as a fair value measurement. The fair values of other investments carried at fair value, such as direct private equity holdings, are initially determined based on transaction price and are subsequently estimated based on available evidence such as market transactions in similar instruments and other financing transactions of the issuer, with adjustments made to reflect illiquidity as appropriate.

Short-term Investments

 

For short-term investments that are measured at fair value, the carrying values of these assets approximate fair values because of the relatively short period of time between origination and expected realization, and their limited exposure to credit risk. Securities purchased under agreements to resell (reverse repurchase agreements) are generally treated as collateralized receivables. We report certain receivables arising from securities purchased under agreements to resell as Short-term investments in the Consolidated Balance Sheet. We use market-observable interest rates for receivables measured at fair value. This methodology considers such factors as the coupon rate and yield curves.

Separate Account Assets

 

Separate account assets are composed primarily of registered and unregistered open-end mutual funds that generally trade daily and are measured at fair value in the manner discussed above for equity securities traded in active markets.

Freestanding Derivatives

 

Derivative assets and liabilities can be exchange-traded or traded over-the-counter (OTC). We generally value exchange-traded derivatives such as futures and options using quoted prices in active markets for identical derivatives at the balance sheet date.

OTC derivatives are valued using market transactions and other market evidence whenever possible, including market-based inputs to models, model calibration to market clearing transactions, broker or dealer quotations or alternative pricing sources with reasonable levels of price transparency. When models are used, the selection of a particular model to value an OTC derivative depends on the contractual terms of, and specific risks inherent in the instrument, as well as the availability of pricing information in the market. We generally use similar models to value similar instruments. Valuation models require a variety of inputs, including contractual terms, market prices and rates, yield curves, credit curves, measures of volatility, prepayment rates and correlations of such inputs. For OTC derivatives that trade in liquid markets, such as generic forwards, swaps and options, model inputs can generally be corroborated by observable market data by correlation or other means, and model selection does not involve significant management judgment.

For certain OTC derivatives that trade in less liquid markets, where we generally do not have corroborating market evidence to support significant model inputs and cannot verify the model to market transactions, the transaction price may provide the best estimate of fair value. Accordingly, when a pricing model is used to value such an instrument, the model is adjusted so the model value at inception equals the transaction price. We will update valuation inputs in these models only when corroborated by evidence such as similar market transactions, third party pricing services and/or broker or dealer quotations, or other empirical market data. When appropriate, valuations are adjusted for various factors such as liquidity, bid/offer spreads and credit considerations. Such adjustments are generally based on available market evidence. In the absence of such evidence, management's best estimate is used.

Embedded Policy Derivatives

 

Certain variable annuity and equity-indexed annuity and life contracts contain embedded policy derivatives that we bifurcate from the host contracts and account for separately at fair value, with changes in fair value recognized in earnings. We have concluded these contracts contain (i) written option guarantees on minimum accumulation value, (ii) a series of written options that guarantee withdrawals from the highest anniversary value within a specific period or for life, or (iii) equity-indexed written options that meet the criteria of derivatives that must be bifurcated.

The fair value of embedded policy derivatives contained in certain variable annuity and equity-indexed annuity and life contracts is measured based on actuarial and capital market assumptions related to projected cash flows over the expected lives of the contracts. These cash flow estimates primarily include benefits and related fees assessed, when applicable, and incorporate expectations about policyholder behavior. Estimates of future policyholder behavior are subjective and based primarily on our historical experience.

With respect to embedded policy derivatives in our variable annuity contracts, because of the dynamic and complex nature of the expected cash flows, risk neutral valuations are used. Estimating the underlying cash flows for these products involves judgments regarding expected market rates of return, market volatility, correlations of market index returns to funds, fund performance, discount rates and policyholder behavior. With respect to embedded policy derivatives in our equity-indexed annuity and life contracts, option pricing models are used to estimate fair value, taking into account assumptions for future equity index growth rates, volatility of the equity index, future interest rates, and determinations on adjusting the participation rate and the cap on equity-indexed credited rates in light of market conditions and policyholder behavior assumptions. These methodologies incorporate an explicit risk margin to take into consideration market participant estimates of projected cash flows and policyholder behavior.

We also incorporate our own risk of non-performance in the valuation of the embedded policy derivatives associated with variable annuity and equity-indexed annuity and life contracts. Historically, the expected cash flows were discounted using the interest rate swap curve (swap curve), which is commonly viewed as being consistent with the credit spreads for highly-rated financial institutions (S&P AA-rated or above). A swap curve shows the fixed-rate leg of a non-complex swap against the floating rate (for example, LIBOR) leg of a related tenor. The swap curve was adjusted, as necessary, for anomalies between the swap curve and the U.S. Treasury yield curve. During the fourth quarter of 2010, we revised the non-performance risk adjustment to reflect a market participant's view of AIG Life and Retirement's claims paying ability. As a result, in 2010, we incorporated an additional spread to the swap curve used to value embedded policy derivatives, thereby reducing the fair value of the embedded derivative liabilities by $336 million, which was partially offset by $173 million of DAC amortization.

Super Senior Credit Default Swap Portfolio

 

We value CDS transactions written on the super senior risk layers of designated pools of debt securities or loans using internal valuation models, third-party price estimates and market indices. The principal market was determined to be the market in which super senior credit default swaps of this type and size would be transacted, or have been transacted, with the greatest volume or level of activity. We have determined that the principal market participants, therefore, would consist of other large financial institutions who participate in sophisticated over-the-counter derivatives markets. The specific valuation methodologies vary based on the nature of the referenced obligations and availability of market prices.

The valuation of the super senior credit derivatives is challenging given the limitation on the availability of market observable information due to the lack of trading and price transparency in certain structured finance markets. These market conditions have increased the reliance on management estimates and judgments in arriving at an estimate of fair value for financial reporting purposes. Further, disparities in the valuation methodologies employed by market participants and the varying judgments reached by such participants when assessing volatile markets have increased the likelihood that the various parties to these instruments may arrive at significantly different estimates as to their fair values.

Our valuation methodologies for the super senior credit default swap portfolio have evolved over time in response to market conditions and the availability of market observable information. We have sought to calibrate the methodologies to available market information and to review the assumptions of the methodologies on a regular basis.

Regulatory capital portfolio:    In the case of credit default swaps written to facilitate regulatory capital relief, we estimate the fair value of these derivatives by considering observable market transactions. The transactions with the most observability are the early terminations of these transactions by counterparties. We continue to reassess the expected maturity of the portfolio. There has been no requirement to make any payments as part of terminations of super senior regulatory capital CDSs initiated by counterparties. In assessing the fair value of the regulatory capital CDS transactions, we also consider other market data, to the extent relevant and available.

Multi-sector CDO portfolios:    We use a modified version of the Binomial Expansion Technique (BET) model to value our credit default swap portfolio written on super senior tranches of multi-sector CDOs of ABS. The BET model was developed in 1996 by a major rating agency to generate expected loss estimates for CDO tranches and derive a credit rating for those tranches, and remains widely used.

We have adapted the BET model to estimate the price of the super senior risk layer or tranche of the CDO. We modified the BET model to imply default probabilities from market prices for the underlying securities and not from rating agency assumptions. To generate the estimate, the model uses the price estimates for the securities comprising the portfolio of a CDO as an input and converts those estimates to credit spreads over current LIBOR-based interest rates. These credit spreads are used to determine implied probabilities of default and expected losses on the underlying securities. This data is then aggregated and used to estimate the expected cash flows of the super senior tranche of the CDO.

Prices for the individual securities held by a CDO are obtained in most cases from the CDO collateral managers, to the extent available. CDO collateral managers provided market prices for 59 percent of the underlying securities used in the valuation at December 31, 2012. When a price for an individual security is not provided by a CDO collateral manager, we derive the price through a pricing matrix using prices from CDO collateral managers for similar securities. Matrix pricing is a mathematical technique used principally to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the relationship of the security to other benchmark quoted securities. Substantially all of the CDO collateral managers who provided prices used dealer prices for all or part of the underlying securities, in some cases supplemented by third-party pricing services.

The BET model also uses diversity scores, weighted average lives, recovery rates and discount rates. We employ a Monte Carlo simulation to assist in quantifying the effect on the valuation of the CDO of the unique aspects of the CDO's structure such as triggers that divert cash flows to the most senior part of the capital structure. The Monte Carlo simulation is used to determine whether an underlying security defaults in a given simulation scenario and, if it does, the security's implied random default time and expected loss. This information is used to project cash flow streams and to determine the expected losses of the portfolio.

In addition to calculating an estimate of the fair value of the super senior CDO security referenced in the credit default swaps using our internal model, we also consider the price estimates for the super senior CDO securities provided by third parties, including counterparties to these transactions, to validate the results of the model and to determine the best available estimate of fair value. In determining the fair value of the super senior CDO security referenced in the credit default swaps, we use a consistent process that considers all available pricing data points and eliminates the use of outlying data points. When pricing data points are within a reasonable range an averaging technique is applied.

Corporate debt/Collateralized loan obligation (CLO) portfolios:    In the case of credit default swaps written on portfolios of investment-grade corporate debt, we use a mathematical model that produces results that are closely aligned with prices received from third parties. This methodology uses the current market credit spreads of the names in the portfolios along with the base correlations implied by the current market prices of comparable tranches of the relevant market traded credit indices as inputs.

We estimate the fair value of our obligations resulting from credit default swaps written on CLOs to be equivalent to the par value less the current market value of the referenced obligation. Accordingly, the value is determined by obtaining third-party quotations on the underlying super senior tranches referenced under the credit default swap contract.

Policyholder Contract Deposits

 

Policyholder contract deposits accounted for at fair value are measured using an earnings approach by taking into consideration the following factors:

•
Current policyholder account values and related surrender charges;

•
The present value of estimated future cash inflows (policy fees) and outflows (benefits and maintenance expenses) associated with the product using risk neutral valuations, incorporating expectations about policyholder behavior, market returns and other factors; and

•
A risk margin that market participants would require for a market return and the uncertainty inherent in the model inputs.

The change in fair value of these policyholder contract deposits is recorded as Policyholder benefits and claims incurred in the Consolidated Statement of Operations.

Long-Term Debt

 

The fair value of non-structured liabilities is generally determined by using market prices from exchange or dealer markets, when available, or discounting expected cash flows using the appropriate discount rate for the applicable maturity. We determine the fair value of structured liabilities and hybrid financial instruments (where performance is linked to structured interest rates, inflation or currency risks) using the appropriate derivative valuation methodology (described above) given the nature of the embedded risk profile. In addition, adjustments are made to the valuations of both non-structured and structured liabilities to reflect our own creditworthiness based on the methodology described under the caption "Incorporation of Credit Risk in Fair Value Measurements – Our Own Credit Risk" above.

Borrowings under obligations of Guaranteed Investment Agreements (GIAs), which are guaranteed by us, are recorded at fair value using discounted cash flow calculations based on interest rates currently being offered for similar contracts and our current market observable implicit credit spread rates with maturities consistent with those remaining for the contracts being valued. Obligations may be called at various times prior to maturity at the option of the counterparty. Interest rates on these borrowings are primarily fixed, vary by maturity and range up to 9.8 percent.

Other Liabilities

 

Other liabilities measured at fair value include certain securities sold under agreements to repurchase and certain securities and spot commodities sold but not yet purchased. Liabilities arising from securities sold under agreements to repurchase are generally treated as collateralized borrowings. We estimate the fair value of liabilities arising under these agreements by using market-observable interest rates. This methodology considers such factors as the coupon rate, yield curves and other relevant factors. Fair values for securities sold but not yet purchased are based on current market prices. Fair values of spot commodities sold but not yet purchased are based on current market prices of reference spot futures contracts traded on exchanges.

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

The following table presents information about assets and liabilities measured at fair value on a recurring basis and indicates the level of the fair value measurement based on the observability of the inputs used:

 
  
   
December 31, 2012
(in millions)
   Level 1
   Level 2
   Level 3
   Counterparty
Netting(a)
   Cash
Collateral(b)
   Total
  
   

Assets:

                                      

Bonds available for sale:

                                      

U.S. government and government sponsored entities             

   $ –   $ 3,483   $ –   $ –   $ –   $ 3,483  

Obligations of states, municipalities and political subdivisions

     –     34,681     1,024     –     –     35,705  

Non-U.S. governments

     1,004     25,782     14     –     –     26,800  

Corporate debt

     –     149,625     1,487     –     –     151,112  

RMBS

     –     22,730     11,662     –     –     34,392  

CMBS

     –     5,010     5,124     –     –     10,134  

CDO/ABS

     –     3,492     4,841     –     –     8,333  
   

Total bonds available for sale

     1,004     244,803     24,152     –     –     269,959  
   

Bond trading securities:

                                      

U.S. government and government sponsored entities

     266     6,528     –     –     –     6,794  

Obligations of states, municipalities and political subdivisions

     –     –     –     –     –     –  

Non-U.S. governments

     –     2     –     –     –     2  

Corporate debt

     –     1,320     –     –     –     1,320  

RMBS

     –     1,331     396     –     –     1,727  

CMBS

     –     1,424     812     –     –     2,236  

CDO/ABS

     –     3,969     8,536     –     –     12,505  
   

Total bond trading securities

     266     14,574     9,744     –     –     24,584  
   

Equity securities available for sale:

                                      

Common stock

     3,002     3     24     –     –     3,029  

Preferred stock

     –     34     44     –     –     78  

Mutual funds

     83     22     –     –     –     105  
   

Total equity securities available for sale

     3,085     59     68     –     –     3,212  
   

Equity securities trading

     578     84     –     –     –     662  

Mortgage and other loans receivable

     –     134     –     –     –     134  

Other invested assets

     125     1,542     5,389     –     –     7,056  

Derivative assets:

                                      

Interest rate contracts

     2     5,521     956     –     –     6,479  

Foreign exchange contracts

     –     104     –     –     –     104  

Equity contracts

     104     63     54     –     –     221  

Commodity contracts

     –     144     1     –     –     145  

Credit contracts

     –     –     60     –     –     60  

Other contracts

     –     –     38     –     –     38  

Counterparty netting and cash collateral

     –     –     –     (2,467 )   (909 )   (3,376 )
   

Total derivative assets

     106     5,832     1,109     (2,467 )   (909 )   3,671  
   

Short-term investments

     285     7,771     –     –     –     8,056  

Separate account assets

     54,430     2,907     –     –     –     57,337  

Other assets

     –     696     –     –     –     696  
   

Total

   $ 59,879   $ 278,402   $ 40,462   $ (2,467 ) $ (909 ) $ 375,367  
   

Liabilities:

                                      

Policyholder contract deposits

   $ –   $ –   $ 1,257   $ –   $ –   $ 1,257  

Derivative liabilities:

                                      

Interest rate contracts

     –     5,582     224     –     –     5,806  

Foreign exchange contracts

     –     174     –     –     –     174  

Equity contracts

     –     114     7     –     –     121  

Commodity contracts

     –     146     –     –     –     146  

Credit contracts(d)

     –     –     2,051     –     –     2,051  

Other contracts

     –     6     200     –     –     206  

Counterparty netting and cash collateral

     –     –     –     (2,467 )   (1,976 )   (4,443 )
   

Total derivative liabilities

     –     6,022     2,482     (2,467 )   (1,976 )   4,061  
   

Long-term debt(e)

     –     7,711     344     –     –     8,055  

Other liabilities

     30     1,050     –     –     –     1,080  
   

Total

   $ 30   $ 14,783   $ 4,083   $ (2,467 ) $ (1,976 ) $ 14,453  
   

 

   
December 31, 2011
(in millions)
   Level 1
   Level 2
   Level 3
   Counterparty
Netting(a)
   Cash
Collateral(b)
   Total
  
   

Assets:

                                      

Bonds available for sale:

                                      

U.S. government and government sponsored entities             

   $ 174   $ 5,904   $ –   $ –   $ –   $ 6,078  

Obligations of states, municipalities and political subdivisions

     –     36,538     960     –     –     37,498  

Non-U.S. governments

     259     25,467     9     –     –     25,735  

Corporate debt

     –     142,883     1,935     –     –     144,818  

RMBS

     –     23,727     10,877     –     –     34,604  

CMBS

     –     3,991     3,955     –     –     7,946  

CDO/ABS

     –     3,082     4,220     –     –     7,302  
   

Total bonds available for sale

     433     241,592     21,956     –     –     263,981  
   

Bond trading securities:

                                      

U.S. government and government sponsored entities

     100     6,362     –     –     –     6,462  

Obligations of states, municipalities and political subdivisions

     –     257     –     –     –     257  

Non-U.S. governments

     –     35     –     –     –     35  

Corporate debt

     –     809     7     –     –     816  

RMBS

     –     1,345     303     –     –     1,648  

CMBS

     –     1,283     554     –     –     1,837  

CDO/ABS

     –     4,877     8,432     –     –     13,309  
   

Total bond trading securities

     100     14,968     9,296     –     –     24,364  
   

Equity securities available for sale:

                                      

Common stock

     3,294     70     57     –     –     3,421  

Preferred stock

     –     44     99     –     –     143  

Mutual funds

     55     5     –     –     –     60  
   

Total equity securities available for sale

     3,349     119     156     –     –     3,624  
   

Equity securities trading

     43     82     –     –     –     125  

Mortgage and other loans receivable

     –     106     1     –     –     107  

Other invested assets(c)

     12,549     1,709     6,618     –     –     20,876  

Derivative assets:

                                      

Interest rate contracts

     2     7,251     1,033     –     –     8,286  

Foreign exchange contracts

     –     143     2     –     –     145  

Equity contracts

     92     133     38     –     –     263  

Commodity contracts

     –     134     2     –     –     136  

Credit contracts

     –     –     89     –     –     89  

Other contracts

     29     462     250     –     –     741  

Counterparty netting and cash collateral

     –     –     –     (3,660 )   (1,501 )   (5,161 )
   

Total derivative assets

     123     8,123     1,414     (3,660 )   (1,501 )   4,499  
   

Short-term investments

     2,309     3,604     –     –     –     5,913  

Separate account assets

     48,502     2,886     –     –     –     51,388  
   

Total

   $ 67,408   $ 273,189   $ 39,441   $ (3,660 ) $ (1,501 ) $ 374,877  
   

Liabilities:

                                      

Policyholder contract deposits

   $ –   $ –   $ 918   $ –   $ –   $ 918  

Derivative liabilities:

                                      

Interest rate contracts

     –     6,661     248     –     –     6,909  

Foreign exchange contracts

     –     178     –     –     –     178  

Equity contracts

     –     198     10     –     –     208  

Commodity contracts

     –     146     –     –     –     146  

Credit contracts(d)

     –     4     3,362     –     –     3,366  

Other contracts

     –     155     217     –     –     372  

Counterparty netting and cash collateral

     –     –     –     (3,660 )   (2,786 )   (6,446 )
   

Total derivative liabilities

     –     7,342     3,837     (3,660 )   (2,786 )   4,733  
   

Long-term debt(e)

     –     10,258     508     –     –     10,766  

Other liabilities

     193     714     –     –     –     907  
   

Total

   $ 193   $ 18,314   $ 5,263   $ (3,660 ) $ (2,786 ) $ 17,324  
   

(a)     Represents netting of derivative exposures covered by a qualifying master netting agreement.

(b)     Represents cash collateral posted and received. Securities collateral posted for derivative transactions that is reflected in Fixed maturity securities in the Consolidated Balance Sheet, and collateral received, not reflected in the Consolidated Balance Sheet, were $1.9 billion and $299 million, respectively, at December 31, 2012 and $1.8 billion and $100 million, respectively, at December 31, 2011.

(c)     Level 1 Other invested assets included $12.4 billion at December 31, 2011 of AIA ordinary shares publicly traded on the Hong Kong Stock Exchange.

(d)     Level 3 Credit contracts included the fair value derivative liability on the super senior credit default swap portfolio of $2.0 billion and $3.2 billion at December 31, 2012 and 2011, respectively.

(e)     Includes Guaranteed Investment Agreements (GIAs), notes, bonds, loans and mortgages payable.

 

Transfers of Level 1 and Level 2 Assets and Liabilities

 

Our policy is to record transfers of assets and liabilities between Level 1 and Level 2 at their fair values as of the end of each reporting period, consistent with the date of the determination of fair value. Assets are transferred out of Level 1 when they are no longer transacted with sufficient frequency and volume in an active market. Conversely, assets are transferred from Level 2 to Level 1 when transaction volume and frequency are indicative of an active market. During the year ended December 31, 2012, we transferred $464 million of securities issued by Non-U.S. government entities from Level 1 to Level 2, as they are no longer considered actively traded. For similar reasons, during the year ended December 31, 2012, we transferred $888 million of securities issued by the U.S. government and government-sponsored entities from Level 1 to Level 2. We had no material transfers from Level 2 to Level 1 during the year ended December 31, 2012.

 

Changes in Level 3 Recurring Fair Value Measurements

 

The following tables present changes during December 31, 2012 and 2011 in Level 3 assets and liabilities measured at fair value on a recurring basis, and the realized and unrealized gains (losses) related to the Level 3 assets and liabilities in the Consolidated Balance Sheet at December 31, 2012 and 2011:

 
  
   
(in millions)
   Fair value
Beginning
of Year(a)
   Net
Realized and
Unrealized
Gains (Losses)
Included
in Income
   Accumulated
Other
Comprehensive
Income (Loss)
   Purchases,
Sales,
Issues and
Settlements, Net
   Gross
Transfers
in
   Gross
Transfers
out
   Fair value
End
of Year
   Changes in
Unrealized Gains
(Losses) Included
in Income on
Instruments Held
at End of Year
  
   

December 31, 2012

                                                  

Assets:

                                                  

Bonds available for sale:

                                                  

Obligations of states, municipalities and political subdivisions

   $ 960   $ 48   $ 12   $ 84   $ 70   $ (150 ) $ 1,024   $ –  

Non-U.S. governments

     9     1     (1 )   1     4     –     14     –  

Corporate debt

     1,935     (44 )   145     24     664     (1,237 )   1,487     –  

RMBS

     10,877     522     2,121     (316 )   952     (2,494 )   11,662     –  

CMBS

     3,955     (135 )   786     636     44     (162 )   5,124     –  

CDO/ABS

     4,220     334     289     10     691     (703 )   4,841     –  
   

Total bonds available for sale

     21,956     726     3,352     439     2,425     (4,746 )   24,152     –  
   

Bond trading securities:

                                                  

Corporate debt

     7     –     –     (7 )   –     –     –     –  

RMBS

     303     76     2     (109 )   128     (4 )   396     42  

CMBS

     554     70     2     (159 )   446     (101 )   812     87  

CDO/ABS

     8,432     3,683     3     (3,968 )   386     –     8,536     2,547  
   

Total bond trading securities

     9,296     3,829     7     (4,243 )   960     (105 )   9,744     2,676  
   

Equity securities available for sale:

                                                  

Common stock

     57     22     (28 )   (33 )   6     –     24     –  

Preferred stock

     99     17     (35 )   (36 )   11     (12 )   44     –  
   

Total equity securities available for sale

     156     39     (63 )   (69 )   17     (12 )   68     –  
   

Mortgage and other loans receivable

     1     –     –     (1 )   –     –     –     –  

Other invested assets

     6,618     (95 )   290     (257 )   1,204     (2,371 )   5,389     –  
   

Total

   $ 38,027   $ 4,499   $ 3,586   $ (4,131 ) $ 4,606   $ (7,234 ) $ 39,353   $ 2,676  
   

Liabilities:

                                                  

Policyholder contract deposits

   $ (918 ) $ (275 ) $ (72 ) $ 8   $ –   $ –   $ (1,257 ) $ 112  

Derivative liabilities, net:

                                                  

Interest rate contracts

     785     (11 )   –     (42 )   –     –     732     56  

Foreign exchange contracts

     2     –     –     (2 )   –     –     –     –  

Equity contracts

     28     10     –     12     (3 )   –     47     (10 )

Commodity contracts

     2     5     –     (6 )   –     –     1     (6 )

Credit contracts

     (3,273 )   638     –     644     –     –     (1,991 )   (1,172 )

Other contracts

     33     (76 )   (18 )   15     (116 )   –     (162 )   46  
   

Total derivative liabilities, net

     (2,423 )   566     (18 )   621     (119 )   –     (1,373 )   (1,086 )
   

Long-term debt(b)

     (508 )   (411 )   (77 )   242     (14 )   424     (344 )   105  
   

Total

   $ (3,849 ) $ (120 ) $ (167 ) $ 871   $ (133 ) $ 424   $ (2,974 ) $ (869 )
   

   
(in millions)
   Fair
value
Beginning
of Year(a)
   Net
Realized and
Unrealized
Gains (Losses)
Included
in Income
   Accumulated
Other
Comprehensive
Income (Loss)
   Purchases,
Sales,
Issues and
Settlements, Net
   Gross
Transfers
In
   Gross
Transfers
Out
   Fair value
End
of Year
   Changes in
Unrealized Gains
(Losses) Included
in Income on
Instruments Held
at End of Year
  
   

December 31, 2011

                                                  

Assets:

                                                  

Bonds available for sale:

                                                  

Obligations of states, municipalities and political subdivisions

   $ 609   $ 2   $ 112   $ 296   $ 17   $ (76 ) $ 960   $ –  

Non-U.S. governments

     5     –     –     5     –     (1 )   9     –  

Corporate debt

     2,262     11     (25 )   171     2,480     (2,964 )   1,935     –  

RMBS

     6,367     (50 )   288     3,232     1,093     (53 )   10,877     –  

CMBS

     3,604     (100 )   239     207     134     (129 )   3,955     –  

CDO/ABS

     4,241     73     142     (432 )   852     (656 )   4,220     –  
   

Total bonds available for sale

     17,088     (64 )   756     3,479     4,576     (3,879 )   21,956     –  
   

Bond trading securities:

                                                  

Corporate debt

     –     –     –     (11 )   18     –     7     1  

RMBS

     91     (27 )   –     239     –     –     303     (28 )

CMBS

     506     92     –     (95 )   292     (241 )   554     87  

CDO/ABS

     9,431     (660 )   –     (323 )   48     (64 )   8,432     (677 )
   

Total bond trading securities

     10,028     (595 )   –     (190 )   358     (305 )   9,296     (617 )
   

Equity securities available for sale:

                                                  

Common stock

     61     28     (4 )   (40 )   18     (6 )   57     –  

Preferred stock

     64     (1 )   32     (1 )   5     –     99     –  

Mutual funds

     –     –     –     (6 )   6     –     –     –  
   

Total equity securities available for sale

     125     27     28     (47 )   29     (6 )   156     –  
   

Equity securities trading

     1     –     –     (1 )   –     –     –     –  

Mortgage and other loans receivable

     –     –     –     1     –     –     1     –  

Other invested assets

     7,414     (10 )   139     (739 )   251     (437 )   6,618     2  
   

Total

   $ 34,656   $ (642 ) $ 923   $ 2,503   $ 5,214   $ (4,627 ) $ 38,027   $ (615 )
   

Liabilities:

                                                  

Policyholder contract deposits

   $ (445 ) $ (429 ) $ –   $ (44 ) $ –   $ –   $ (918 ) $ 508  

Derivative liabilities, net:

                                                  

Interest rate contracts

     732     46     –     (2 )   30     (21 )   785     (90 )

Foreign exchange contracts

     16     (11 )   –     (5 )   2     –     2     1  

Equity contracts

     22     (16 )   –     41     (7 )   (12 )   28     (15 )

Commodity contracts

     23     1     –     (22 )   –     –     2     (1 )

Credit contracts

     (3,798 )   332     –     193     –     –     (3,273 )   493  

Other contracts

     (112 )   (14 )   (51 )   74     (30 )   166     33     (98 )
   

Total derivatives liabilities, net

     (3,117 )   338     (51 )   279     (5 )   133     (2,423 )   290  
   

Long-term debt(b)

     (982 )   (60 )   –     555     (21 )   –     (508 )   (135 )
   

Total

   $ (4,544 ) $ (151 ) $ (51 ) $ 790   $ (26 ) $ 133   $ (3,849 ) $ 663  
   

(a)     Total Level 3 derivative exposures have been netted in these tables for presentation purposes only.

(b)     Includes GIAs, notes, bonds, loans and mortgages payable.

Net realized and unrealized gains and losses related to Level 3 items shown above are reported in the Consolidated Statement of Operations as follows:

   
(in millions)
   Net
Investment
Income
   Net Realized
Capital
Gains (Losses)
   Other
Income
   Total
  
   

December 31, 2012

                          

Bonds available for sale

   $ 906   $ (395 ) $ 215   $ 726  

Bond trading securities

     3,303     –     526     3,829  

Equity securities

     –     39     –     39  

Other invested assets

     54     (210 )   61     (95 )

Policyholder contract deposits

     –     (275 )   –     (275 )

Derivative liabilities, net

     3     26     537     566  

Other long-term debt

     –     –     (411 )   (411 )
   

December 31, 2011

                          

Bonds available for sale

   $ 638   $ (717 ) $ 15   $ (64 )

Bond trading securities

     (634 )   4     35     (595 )

Equity securities

     –     27     –     27  

Other invested assets

     23     (84 )   51     (10 )

Policyholder contract deposits

     –     (499 )   70     (429 )

Derivative liabilities, net

     2     13     323     338  

Other long-term debt

     –     –     (60 )   (60 )
   

The following table presents the gross components of purchases, sales, issues and settlements, net, shown above:

 
    
    
    
    
  
   
(in millions)
   Purchases
   Sales
   Settlements
   Purchases, Sales,
Issues and
Settlements, Net(a)
  
   

December 31, 2012

                          

Assets:

                          

Bonds available for sale:

                          

Obligations of states, municipalities and political subdivisions

   $ 477   $ (219 ) $ (174 ) $ 84  

Non-U.S. governments

     5     (3 )   (1 )   1  

Corporate debt

     283     (75 )   (184 )   24  

RMBS

     2,308     (723 )   (1,901 )   (316 )

CMBS

     1,137     (318 )   (183 )   636  

CDO/ABS

     1,120     (4 )   (1,106 )   10  
   

Total bonds available for sale

     5,330     (1,342 )   (3,549 )   439  
   

Bond trading securities:

                          

Corporate debt

     –     –     (7 )   (7 )

RMBS

     –     (45 )   (64 )   (109 )

CMBS

     225     (106 )   (278 )   (159 )

CDO/ABS(b)

     7,382     (21 )   (11,329 )   (3,968 )
   

Total bond trading securities

     7,607     (172 )   (11,678 )   (4,243 )
   

Equity securities

     67     (56 )   (80 )   (69 )

Mortgage and other loans receivable

     –     –     (1 )   (1 )

Other invested assets

     900     (100 )   (1,057 )   (257 )
   

Total assets

   $ 13,904   $ (1,670 ) $ (16,365 ) $ (4,131 )
   

Liabilities:

                          

Policyholder contract deposits

   $ –   $ (25 ) $ 33   $ 8  

Derivative liabilities, net

     11     (2 )   612     621  

Other long-term debt(c)

     –     –     242     242  
   

Total liabilities

   $ 11   $ (27 ) $ 887   $ 871  
   

December 31, 2011

                          

Assets:

                          

Bonds available for sale:

                          

Obligations of states, municipalities and political subdivisions

   $ 305   $ (4 ) $ (5 ) $ 296  

Non-U.S. governments

     4     (2 )   3     5  

Corporate debt

     497     (27 )   (299 )   171  

RMBS

     4,932     (205 )   (1,495 )   3,232  

CMBS

     470     (34 )   (229 )   207  

CDO/ABS

     1,067     (1 )   (1,498 )   (432 )
   

Total bonds available for sale

     7,275     (273 )   (3,523 )   3,479  
   

Bond trading securities:

                          

Corporate debt

     –     –     (11 )   (11 )

RMBS

     305     (1 )   (65 )   239  

CMBS

     221     (207 )   (109 )   (95 )

CDO/ABS

     331     (304 )   (350 )   (323 )
   

Total bond trading securities

     857     (512 )   (535 )   (190 )
   

Equity securities

     –     (31 )   (17 )   (48 )

Mortgage and other loans receivable

     –     –     1     1  

Other invested assets

     718     (296 )   (1,161 )   (739 )
   

Total assets

   $ 8,850   $ (1,112 ) $ (5,235 ) $ 2,503  
   

Liabilities:

                          

Policyholder contract deposits

   $ –   $ (70 ) $ 26   $ (44 )

Derivative liabilities, net

     43     –     236     279  

Other long-term debt(c)

     –     –     555     555  
   

Total liabilities

   $ 43   $ (70 ) $ 817   $ 790  
   

(a)     There were no issuances during year ended December 31, 2012.

(b)     Includes $7.1 billion of securities purchased through the FRBNY's auction of ML III assets.

(c)     Includes GIAs, notes, bonds, loans and mortgages payable.

Both observable and unobservable inputs may be used to determine the fair values of positions classified in Level 3 in the tables above. As a result, the unrealized gains (losses) on instruments held at December 31, 2012 and 2011 may include changes in fair value that were attributable to both observable (e.g., changes in market interest rates) and unobservable inputs (e.g., changes in unobservable long-dated volatilities).

Transfers of Level 3 Assets and Liabilities

 

We record transfers of assets and liabilities into or out of Level 3 at their fair values as of the end of each reporting period, consistent with the date of the determination of fair value. As a result, the Net realized and unrealized gains (losses) included in income or other comprehensive income and as shown in the table above excludes $143 million of net losses related to assets and liabilities transferred into Level 3 during 2012, and includes $92 million of net gains related to assets and liabilities transferred out of Level 3 during 2012.

Transfers of Level 3 Assets

During the year ended December 31, 2012, transfers into Level 3 assets included certain RMBS, CMBS, CDO/ABS, private placement corporate debt and certain private equity funds and hedge funds. Transfers of certain RMBS and certain CDO/ABS into Level 3 assets were related to decreased observations of market transactions and price information for those securities. The transfers of investments in certain other RMBS and CMBS into Level 3 assets were due to a decrease in market transparency, downward credit migration and an overall increase in price disparity for certain individual security types. Transfers of private placement corporate debt and certain other ABS into Level 3 assets were primarily the result of limited market pricing information that required us to determine fair value for these securities based on inputs that are adjusted to better reflect our own assumptions regarding the characteristics of a specific security or associated market liquidity. Certain private equity fund and hedge fund investments were also transferred into Level 3 due to these investments being carried at fair value and no longer being accounted for using the equity method of accounting, consistent with the changes to our ownership and the lack of ability to exercise more than minor influence over the respective investments. Other hedge fund investments were transferred into Level 3 as a result of limited market activity due to fund-imposed redemption restrictions.

Assets are transferred out of Level 3 when circumstances change such that significant inputs can be corroborated with market observable data. This may be due to a significant increase in market activity for the asset, a specific event, one or more significant input(s) becoming observable or a long-term interest rate significant to a valuation becoming short-term and thus observable. In addition, transfers out of Level 3 assets also occur when investments are no longer carried at fair value as the result of a change in the applicable accounting methodology, given changes in the nature and extent of our ownership interest. During the year ended December 31, 2012, transfers out of Level 3 assets primarily related to certain RMBS, CMBS, ABS, investments in private placement corporate debt and private equity funds and hedge funds. Transfers of certain RMBS out of Level 3 assets were based on consideration of the market liquidity as well as related transparency of pricing and associated observable inputs for these investments. Transfers of investments in certain CMBS out of Level 3 were due to an increase in market transparency, positive credit migration and an overall improvement in price comparability for certain individual security types. Transfers of ABS and private placement corporate debt out of Level 3 assets were primarily the result of using observable pricing information that reflects the fair value of those securities without the need for adjustment based on our own assumptions regarding the characteristics of a specific security or the current liquidity in the market. The removal of fund-imposed redemption restrictions, as well as certain fund investments becoming subject to the equity method of accounting based on our level of influence over the respective investments, resulted in the transfer of certain hedge fund and private equity fund investments out of Level 3.

Transfers of Level 3 Liabilities

Because we present carrying values of our derivative positions on a net basis in the table above, transfers into Level 3 liabilities for the year ended December 31, 2012 primarily related to certain derivative assets transferred out of Level 3 because of the presence of observable inputs on certain forward commitments and options. During the year ended December 31, 2012, certain notes payable were transferred out of Level 3 liabilities because input parameters for the pricing of these liabilities became more observable as a result of market movements and portfolio aging. There were no significant transfers of derivative liabilities out of Level 3 for the year ended December 31, 2012.

We use various hedging techniques to manage risks associated with certain positions, including those classified within Level 3. Such techniques may include the purchase or sale of financial instruments that are classified within Level 1 and/or Level 2. As a result, the realized and unrealized gains (losses) for assets and liabilities classified within Level 3 presented in the table above do not reflect the related realized or unrealized gains (losses) on hedging instruments that are classified within Level 1 and/or Level 2.

 

Quantitative Information about Level 3 Fair Value Measurements

 

The table below presents information about the significant unobservable inputs used for recurring fair value measurements for certain Level 3 instruments, and includes only those instruments for which information about the inputs is reasonably available to us, such as data from pricing vendors and from internal valuation models. Because input information with respect to certain Level 3 instruments may not be reasonably available to us, balances shown below may not equal total amounts reported for such Level 3 assets and liabilities:

 
    
    
    
    
 
(in millions)
   Fair Value at
December 31, 2012
   Valuation
Technique
   Unobservable Input(a)
   Range
(Weighted Average )(a)
 

Assets:

                  

Corporate debt

   $ 775   Discounted cash flow   Yield(b)   0.08% - 6.55% (3.31%)

RMBS

    
10,650		  
Discounted cash flow		  
Constant prepayment rate(c)		  
0.00% - 10.76% (5.03%)

             Loss severity(c)   43.70% - 78.72% (61.21%)

             Constant default rate(c)   4.21% - 13.30% (8.75%)

             Yield(c)   2.23% - 9.42% (5.82%)

Certain CDO/ABS(d)

    
7,844		  
Discounted cash flow		  
Constant prepayment rate(c)		  
0.00% - 32.25% (11.82%)

 

             Loss severity(c)   0.00% - 29.38% (6.36%)

 

             Constant default rate(c)   0.00% - 4.05% (1.18%)

 

             Yield(c)   5.41% - 10.67% (8.04%)

Commercial mortgage backed securities

    
3,251		  
Discounted cash flow		  
Yield(b)		  
0.00% - 19.95% (7.76%)

CDO/ABS – Direct

        
Binomial Expansion		  
Recovery rate(b)		  
3% - 63% (27%)

Investment Book

     1,205   Technique (BET)   Diversity score(b)   4 - 44 (13)

             Weighted average life(b)   1.27 - 9.11 years (4.91 years)
 

Liabilities:

                  

Policyholder contract deposits – GMWB

     1,257   Discounted cash flow   Equity implied volatility(b)   6.0% - 39.0%

             Base lapse rates(b)   1.00% - 40.0%

             Dynamic lapse rates(b)   0.2% - 60.0%

             Mortality rates(b)   0.5% - 40.0%

             Utilization rates(b)   0.5% - 25.0%

Derivative Liabilities – Credit contracts

    
1,436		  
BET		  
Recovery rates(b)		  
3% - 37% (17%)

 

             Diversity score(b)   9 - 38 (14)

 

             Weighted average life(b)   5.10 - 8.45 years (5.75 years)
 

(a)     The unobservable inputs and ranges for the constant prepayment rate, loss severity and constant default rate relate to each of the individual underlying mortgage loans that comprise the entire portfolio of securities in the RMBS and CDO securitization vehicles and not necessarily to the securitization vehicle bonds (tranches) purchased by us. The ranges of these inputs do not directly correlate to changes in the fair values of the tranches purchased by us because there are other factors relevant to the specific tranches owned by us including, but not limited to, purchase price, position in the waterfall, senior versus subordinated position and attachment points.

(b)     Represents discount rates, estimates and assumptions that we believe would be used by market participants when valuing these assets and liabilities.

(c)     Information received from independent third-party valuation service providers.

(d)     Yield was the only input available for $6.6 billion of total fair value at December 31, 2012.

The ranges of reported inputs for Corporate debt, RMBS, CDO/ABS, and CMBS valued using a discounted cash flow technique consist of plus/minus one standard deviation in either direction from the value-weighted average. The preceding table does not give effect to our risk management practices that might offset risks inherent in these investments.

Sensitivity to Changes in Unobservable Inputs

 

We consider unobservable inputs to be those for which market data is not available and that are developed using the best information available to us about the assumptions that market participants would use when pricing the asset or liability. Relevant inputs vary depending on the nature of the instrument being measured at fair value. The following is a general description of sensitivities of significant unobservable inputs along with interrelationships between and among the significant unobservable inputs and their impact on the fair value measurements. The effect of a change in a particular assumption in the sensitivity analysis below is considered independently of changes in any other assumptions. In practice, simultaneous changes in assumptions may not always have a linear effect on the inputs discussed below. Interrelationships may also exist between observable and unobservable inputs. Such relationships have not been included in the discussion below. For each of the individual relationships described below, the inverse relationship would also generally apply.

 

Corporate Debt

 

Corporate debt securities included in Level 3 are primarily private placement issuances that are not traded in active markets or that are subject to transfer restrictions. Fair value measurements consider illiquidity and non-transferability. When observable price quotations are not available, fair value is determined based on discounted cash flow models using discount rates based on credit spreads, yields or price levels of publicly-traded debt of the issuer or other comparable securities, considering illiquidity and structure. The significant unobservable input used in the fair value measurement of corporate debt is the yield. The yield is affected by the market movements in credit spreads and U.S. Treasury yields. In addition, the migration in credit quality of a given security generally has a corresponding effect on the fair value measurement of the securities. For example, a downward migration of credit quality would increase spreads. Holding U.S. Treasury rates constant, an increase in corporate credit spreads would decrease the fair value of corporate debt.

 

RMBS and Certain CDO/ABS

 

The significant unobservable inputs used in fair value measurements of RMBS and certain CDO/ABS valued by third-party valuation service providers are constant prepayment rates (CPR), constant default rates (CDR), loss severity, and yield. A change in the assumptions used for the probability of default will generally be accompanied by a corresponding change in the assumption used for the loss severity and an inverse change in the assumption used for prepayment rates. In general, increases in yield, CPR, CDR, and loss severity, in isolation, would result in a decrease in the fair value measurement. Changes in fair value based on variations in assumptions generally cannot be extrapolated because the relationship between the directional change of each input is not usually linear.

 

CMBS

 

The significant unobservable input used in fair value measurements for CMBS is the yield. Prepayment assumptions for each mortgage pool are factored into the yield. CMBS generally feature a lower degree of prepayment risk than RMBS because commercial mortgages generally contain a penalty for prepayment. In general, increases in the yield would decrease the fair value of CMBS.

 

CDO/ABS – Direct Investment book

 

The significant unobservable inputs used for certain CDO/ABS securities valued using the BET are recovery rates, diversity score, and the weighted average life of the portfolio. An increase in recovery rates and diversity score will have a directionally similar corresponding impact on the fair value of the portfolio. An increase in the weighted average life will decrease the fair value.

 

Policyholder contract deposits

 

The significant unobservable inputs used for embedded derivatives in policyholder contract deposits measured at fair value, mainly guaranteed minimum withdrawal benefits (GMWB) for variable annuity products, are equity volatility, mortality rates, lapse rates and utilization rates. Mortality, lapse and utilization rates may vary significantly depending upon age groups and duration. In general, increases in volatility and utilization rates will increase the fair value, while increases in lapse rates and mortality rates will decrease the fair value of the liability associated with the GMWB.

 

Derivative liabilities – credit contracts

 

The significant unobservable inputs used for Derivatives liabilities – credit contracts are recovery rates, diversity scores, and the weighted average life of the portfolio. AIG non-performance risk is also considered in the measurement of the liability.

An increase in recovery rates and diversity score will decrease the fair value of the liability. An increase in the weighted average life will have a directionally similar corresponding effect on the fair value measurement of the liability.

 

Investments in Certain Entities Carried at Fair Value Using Net Asset Value per Share

 

The following table includes information related to our investments in certain other invested assets, including private equity funds, hedge funds and other alternative investments that calculate net asset value per share (or its equivalent). For these investments, which are measured at fair value on a recurring basis, we use the net asset value per share as a practical expedient to measure fair value.

 
    
    
    
    
    
  
   
 
    
   December 31, 2012   December 31, 2011  
(in millions)
  Investment Category Includes
   Fair Value Using
Net Asset Value
Per Share
(or its equivalent)
   Unfunded
Commitments
   Fair Value Using
Net Asset Value
Per Share
(or its equivalent)
   Unfunded
Commitments
  
   

Investment Category

                              

Private equity funds:

                              

Leveraged buyout

   Debt and/or equity investments made as part of a transaction in which assets of mature companies are acquired from the current shareholders, typically with the use of financial leverage   $ 2,549   $ 659   $ 3,185   $ 945  

Non-U.S.

  

Investments that focus primarily on Asian and European based buyouts, expansion capital, special situations, turnarounds, venture capital, mezzanine and distressed opportunities strategies

    
179		    
25		    
165		    
57		  

Venture capital

  

Early-stage, high-potential, growth companies expected to generate a return through an eventual realization event, such as an initial public offering or sale of the company

    
163		    
16		    
316		    
39		  

Distressed

  

Securities of companies that are already in default, under bankruptcy protection, or troubled

    
87		    
21		    
182		    
42		  

Other

  

Real estate, energy, multi-strategy, mezzanine, and industry-focused strategies

    
255		    
152		    
252		    
98		  
   

Total private equity funds

         3,233     873     4,100     1,181  
   

Hedge funds:

                              

Event-driven

   Securities of companies undergoing material structural changes, including mergers, acquisitions and other reorganizations     747     2     774     2  

Long-short

  

Securities that the manager believes are undervalued, with corresponding short positions to hedge market risk

    
1,091		    
–		    
927		    
–		  

Macro

  

Investments that take long and short positions in financial instruments based on a top-down view of certain economic and capital market conditions

    
238		    
–		    
173		    
–		  

Distressed

  

Securities of companies that are already in default, under bankruptcy protection or troubled

    
316		    
–		    
272		    
10		  

Other

  

Non-U.S. companies, futures and commodities, relative value, and multi-strategy and industry-focused strategies

    
416		    
–		    
627		    
–		  
   

Total hedge funds

         2,808     2     2,773     12  
   

Total

       $ 6,041   $ 875   $ 6,873   $ 1,193  
   

Private equity fund investments included above are not redeemable, as distributions from the funds will be received when underlying investments of the funds are liquidated. Private equity funds are generally expected to have 10-year lives at their inception, but these lives may be extended at the fund manager's discretion, typically in one or two-year increments. At December 31, 2012, assuming average original expected lives of 10 years for the funds, 41 percent of the total fair value using net asset value or its equivalent above would have expected remaining lives of less than three years, 56 percent between three and seven years and 3 percent between seven and 10 years.

At December 31, 2012, hedge fund investments included above are redeemable monthly (15 percent), quarterly (34 percent), semi-annually (28 percent) and annually (23 percent), with redemption notices ranging from one day to 180 days. More than 69 percent of these hedge fund investments require redemption notices of less than 90 days. Investments representing approximately 74 percent of the value of the hedge fund investments cannot be redeemed, either in whole or in part, because the investments include various restrictions. The majority of these restrictions have pre-defined end dates and are generally expected to be lifted by the end of 2015. The restrictions that do not have stated end dates were primarily put in place prior to 2009. The partial restrictions relate to certain hedge funds that hold at least one investment that the fund manager deems to be illiquid.

 

Fair Value Option

 

Under the fair value option, we may elect to measure at fair value financial assets and financial liabilities that are not otherwise required to be carried at fair value. Subsequent changes in fair value for designated items are reported in earnings. We elect the fair value option for certain hybrid securities given the complexity of bifurcating the economic components associated with the embedded derivatives. Refer to Note 12 for additional information related to embedded derivatives.

Additionally, beginning in the third quarter of 2012 we elected the fair value option for investments in certain private equity funds, hedge funds and other alternative investments when such investments are eligible for this election. We believe this measurement basis is consistent with the applicable accounting guidance used by the respective investment company funds themselves. Refer to Note 7 herein for additional information.

The following table presents the gains or losses recorded related to the eligible instruments for which we elected the fair value option:

 
    
    
    
  
   
 
   Gain (Loss)  
Years Ended December 31,
(in millions)
  
  2012
   2011
   2010
  
   

Assets:

                    

Mortgage and other loans receivable

   $ 47   $ 11   $ 53  

Bonds and equity securities

     2,339     1,273     2,060  

Trading – ML II interest

     246     42     513  

Trading – ML III interest

     2,888     (646 )   1,792  

Retained interest in AIA

     2,069     1,289     (638 )

Other, including Short-term investments

     56     35     (39 )
   

Liabilities:

                    

Policyholder contract deposits

     –     –     (320 )

Long-term debt(a)

     (681 )   (966 )   (1,595 )

Other liabilities

     (33 )   (67 )   (8 )
   

Total gain(b)

   $ 6,931   $ 971   $ 1,818  
   

(a)     Includes GIAs, notes, bonds, loans and mortgages payable.

(b)     Excludes discontinued operation gains or losses on instruments that were required to be carried at fair value. For instruments required to be carried at fair value, we recognized gains of $586 million, $1.3 billion and $4.9 billion for the years ended 2012, 2011 and 2010, respectively, that were primarily due to changes in the fair value of derivatives, trading securities and certain other invested assets for which the fair value option was not elected.

Interest income and dividend income on assets elected under the fair value option are recognized and included in Net Investment Income in the Consolidated Statement of Operations with the exception of DIB-related activity, which is included in Other income. Interest on liabilities for which we elected the fair value option is recognized in interest expense in the Consolidated Statement of Operations. See Note 7 herein for additional information about our policies for recognition, measurement, and disclosure of interest and dividend income and interest expense.

During 2012, 2011 and 2010, we recognized losses of $641 million, gains of $420 million and losses of $779 million, respectively, attributable to the observable effect of changes in credit spreads on our own liabilities for which the fair value option was elected. We calculate the effect of these credit spread changes using discounted cash flow techniques that incorporate current market interest rates, our observable credit spreads on these liabilities and other factors that mitigate the risk of nonperformance such as cash collateral posted.

The following table presents the difference between fair values and the aggregate contractual principal amounts of mortgage and other loans receivable and long-term borrowings for which the fair value option was elected:

 
    
    
    
    
    
    
  
   
 
   December 31, 2012   December 31, 2011  
(in millions)
   Fair Value
   Outstanding
Principal Amount
   Difference
   Fair Value
   Outstanding
Principal Amount
   Difference
  
   

Assets:

                                      

Mortgage and other loans receivable

   $ 134   $ 141   $ (7 ) $ 107   $ 150   $ (43 )

Liabilities:

                                      

Long-term debt*

   $ 8,055   $ 5,705   $ 2,350   $ 10,766   $ 8,624   $ 2,142  
   

*         Includes GIAs, notes, bonds, loans and mortgages payable.

There were no mortgage or other loans receivable for which the fair value option was elected that were 90 days or more past due or in non-accrual status at December 31, 2012 and 2011.

 

Fair Value Measurements on a Non-Recurring Basis

 

We measure the fair value of certain assets on a non-recurring basis, generally quarterly, annually or when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. These assets include cost and equity-method investments, life settlement contracts, collateral securing foreclosed loans and real estate and other fixed assets, goodwill and other intangible assets. See Note 7 herein for additional information about how we test various asset classes for impairment.

The following table presents assets measured at fair value on a non-recurring basis at the time of impairment and the related impairment charges recorded during the periods presented:

                     
   
 
   Assets at Fair Value   Impairment Charges  
 
   Non-Recurring Basis   December 31,  
(in millions)
   Level 1
   Level 2
   Level 3
   Total
   2012
   2011
   2010
  
   

December 31, 2012

                                            

Investment real estate

   $ –   $ –   $ –   $ –   $ –   $ 18   $ 604  

Other investments

     –     –     2,062     2,062     460     639     323  

Aircraft(a)

     –     –     –     –     –     1,693     1,614  

Other assets

     –     3     18     21     11     3     5  
   

Total

   $ –   $ 3   $ 2,080   $ 2,083   $ 471   $ 2,353   $ 2,546  
   

December 31, 2011

                                            

Investment real estate

   $ –   $ –   $ 457   $ 457                    

Other investments

     –     –     2,199     2,199                    

Aircraft(b)

     –     –     1,683     1,683                    

Other assets

     –     –     4     4                    
   

Total

   $ –   $ –   $ 4,343   $ 4,343                    
   

(a)     See Note 4 for a discussion on the ILFC Transaction.

(b)     Fair value of Aircraft includes aircraft impairment charges.

 

Fair Value Information about Financial Instruments Not Measured at Fair Value

 

Information regarding the estimation of fair value for financial instruments not carried at fair value (excluding insurance contracts and lease contracts) is discussed below:

  • •
    Mortgage and other loans receivable:  Fair values of loans on real estate and other loans receivable were estimated for disclosure purposes using discounted cash flow calculations based upon discount rates that we believe market participants would use in determining the price that they would pay for such assets. For certain loans, our current incremental lending rates for similar types of loans is used as the discount rate, as we believe that this rate approximates the rates that market participants would use. The fair values of policy loans are generally estimated based on unpaid principal amount as of each reporting date or, in some cases, based on the present value of the loans using a discounted cash flow model. No consideration is given to credit risk as policy loans are effectively collateralized by the cash surrender value of the policies.

    •
    Other Invested Assets:  The majority of Other invested assets that are not measured at fair value represent investments in life settlement contracts. The fair value of life settlement contracts included in Other invested assets is determined on a discounted cash flow basis, incorporating current life expectancy assumptions.

    •
    Cash and short-term investments:  The carrying values of these assets approximate fair values because of the relatively short period of time between origination and expected realization, and their limited exposure to credit risk.

    •
    Policyholder contract deposits associated with investment-type contracts:  Fair values for policyholder contract deposits associated with investment-type contracts not accounted for at fair value were estimated using discounted cash flow calculations based upon interest rates currently being offered for similar contracts with maturities consistent with those remaining for the contracts being valued. Where no similar contracts are being offered, the discount rate is the appropriate tenor swap rate (if available) or current risk-free interest rate consistent with the currency in which the cash flows are denominated.

    •
    Long-term debt:  Fair values of these obligations were determined by reference to quoted market prices, where available and appropriate, or discounted cash flow calculations based upon our current market-observable implicit-credit-spread rates for similar types of borrowings with maturities consistent with those remaining for the debt being valued.

The following table presents the carrying value and estimated fair value of our financial instruments not measured at fair value and indicates the level of the estimated fair value measurement based on the observability of the inputs used:

   
 
   Estimated Fair Value    
  
 
   Carrying
Value
  
(in millions)
   Level 1
   Level 2
   Level 3
   Total
  
   

December 31, 2012

                                

Assets:

                                

Mortgage and other loans receivable

   $ –   $ 823   $ 19,396   $ 20,219   $ 19,348  

Other invested assets

     –     237     3,521     3,758     4,932  

Short-term investments

     –     20,752     –     20,752     20,752  

Cash

     1,151     –     –     1,151     1,151  

Liabilities:

                                

Policyholder contract deposits associated with investment-type contracts

     –     245     123,860     124,105     105,979  

Other liabilities

     –     2,205     818     3,023     3,024  

Long-term debt*

     –     43,966     1,925     45,891     40,445  
   

December 31, 2011

                                

Assets:

                                

Mortgage and other loans receivable

                     $ 20,494   $ 19,382  

Other invested assets

                       3,390     4,701  

Short-term investments

                       16,657     16,659  

Cash

                       1,474     1,474  

Liabilities:

                                

Policyholder contract deposits associated with investment-type contracts

                       122,125     106,950  

Other liabilities

                       896     896  

Long-term debt

                       61,295     64,487  
   

* Excludes Long-term debt of ILFC reclassed to Liabilities held for sale on the Consolidated Balance Sheet.