MetLife 2008 Annual Report Download - page 230

amounts presented in the consolidated balance sheet represents those contracts classified as insurance contracts which do not satisfy
the criteria of financial instruments for which fair value is to be disclosed.
Separate account liabilities classified as investment contracts primarily represent variable annuities with no significant mortality risk to
the Company such that the death benefit is equal to the account balance; funding arrangements related to institutional group life contracts;
and certain contracts that provide for benefit funding under Institutional retirement & savings products.
Separate account liabilities, whether related to investment or insurance contracts, are recognized in the consolidated balance sheet at
an equivalent summary total of the separate account assets as prescribed by SOP 03-1. Separate account assets, which equal net
deposits, net investment income and realized and unrealized capital gains and losses, are fully offset by corresponding amounts credited
to the contractholders’ liability which is reflected in separate account liabilities. Since separate account liabilities are fully funded by cash
flows from the separate account assets which are recognized at estimated fair value as described above, the Company believes the value
of those assets approximates the estimated fair value of the related separate account liabilities.
Derivatives — The estimated fair value of derivatives is determined through the use of quoted market prices for exchange-traded
derivatives and financial forwards to sell residential mortgage-backed securities or through the use of pricing models for over-the-counter
derivatives. The determination of estimated fair value, when quoted market values are not available, is based on market standard valuation
methodologies and inputs that are assumed to be consistent with what other market participants would use when pricing the instruments.
Derivative valuations can be affected by changes in interest rates, foreign currency exchange rates, financial indices, credit spreads,
default risk (including the counterparties to the contract), volatility, liquidity and changes in estimates and assumptions used in the pricing
models.
The significant inputs to the pricing models for most over-the-counter derivatives are inputs that are observable in the market or can be
derived principally from or corroborated by observable market data. Significant inputs that are observable generally include: interest rates,
foreign currency exchange rates, interest rate curves, credit curves and volatility. However, certain over-the-counter derivatives may rely on
inputs that are significant to the estimated fair value that are not observable in the market or cannot be derived principally from or
corroborated by observable market data. Significant inputs that are unobservable generally include: independent broker quotes, credit
correlation assumptions, references to emerging market currencies and inputs that are outside the observable portion of the interest rate
curve, credit curve, volatility or other relevant market measure. These unobservable inputs may involve significant management judgment
or estimation. Even though unobservable, these inputs are based on assumptions deemed appropriate given the circumstances and
consistent with what other market participants would use when pricing such instruments.
The credit risk of both the counterparty and the Company are considered in determining the estimated fair value for all over-the-counter
derivatives after taking into account the effects of netting agreements and collateral arrangements. Credit risk is monitored and
consideration of any potential credit adjustment is based on net exposure by counterparty. This is due to the existence of netting
agreements and collateral arrangements which effectively serve to mitigate risk. The Company values its derivative positions using the
standard swap curve which includes a credit risk adjustment. This credit risk adjustment is appropriate for those parties that execute trades
at pricing levels consistent with the standard swap curve. As the Company and its significant derivative counterparties consistently execute
trades at such pricing levels, additional credit risk adjustments are not currently required in the valuation process. The need for such
additional credit risk adjustments is monitored by the Company. The Company’s ability to consistently execute at such pricing levels is in
part due to the netting agreements and collateral arrangements that are in place with all of its significant derivative counterparties.
Most inputs for over-the-counter derivatives are mid market inputs but, in certain cases, bid level inputs are used when they are deemed
more representative of exit value. Market liquidity as well as the use of different methodologies, assumptions and inputs, may have a
material effect on the estimated fair values of the Company’s derivatives and could materially affect net income.
Embedded Derivatives within Asset and Liability Host Contracts — Embedded derivatives principally include certain direct, assumed
and ceded variable annuity riders and certain guaranteed investment contracts with equity or bond indexed crediting rates. Embedded
derivatives are recorded in the financial statements at estimated fair value with changes in estimated fair value adjusted through net
income.
The Company issues certain variable annuity products with guaranteed minimum benefit riders. GMWB, GMAB and certain GMIB riders
are embedded derivatives, which are measured at estimated fair value separately from the host variable annuity contract, with changes in
estimated fair value reported in net investment gains (losses). These embedded derivatives are classified within policyholder account
balances. The fair value for these riders is estimated using the present value of future benefits minus the present value of future fees using
actuarial and capital market assumptions related to the projected cash flows over the expected lives of the contracts. A risk neutral
valuation methodology is used under which the cash flows from the riders are projected under multiple capital market scenarios using
observable risk free rates. Effective January 1, 2008, upon adoption of SFAS 157, the valuation of these riders now includes an adjustment
for the Company’s own credit and risk margins for non-capital market inputs. The Company’s own credit adjustment is determined taking
into consideration publicly available information relating to the Company’s debt as well as its claims paying ability. Risk margins are
established to capture the non-capital market risks of the instrument which represent the additional compensation a market participant
would require to assume the risks related to the uncertainties of such actuarial assumptions as annuitization, premium persistency, partial
withdrawal and surrenders. The establishment of risk margins requires the use of significant management judgment. These riders may be
more costly than expected in volatile or declining equity markets. Market conditions including, but not limited to, changes in interest rates,
equity indices, market volatility and foreign currency exchange rates; changes in the Company’s own credit standing; and variations in
actuarial assumptions regarding policyholder behavior and risk margins related to non-capital market inputs may result in significant
fluctuations in the estimated fair value of the riders that could materially affect net income.
F-107MetLife, Inc.
MetLife, Inc.
Notes to the Consolidated Financial Statements — (Continued)