MetLife 2009 Annual Report Download - page 151

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 interest rate forwards to sell certain to be announced 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 are assumed to be
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, and any potential credit adjustment is based on the net exposure by counterparty after taking into account the effects of netting
agreements and collateral arrangements. The Company values its derivative positions using the standard swap curve which includes a
spread over the risk free rate. This credit spread 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 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. The evaluation of the requirement to make additional credit risk adjustments is performed by the Company each reporting
period.
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 guarantees and certain funding agreements 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 reported in net income.
The Company issues certain variable annuity products with guaranteed minimum benefit guarantees. GMWB, GMAB and certain GMIB 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 guarantees are 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 guarantees are projected under multiple capital market scenarios using observable
risk free rates. The valuation of these guarantees 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 guarantees 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 guarantees that could materially affect net income.
The Company ceded the risk associated with certain of the GMIB and GMAB described in the preceding paragraph. These reinsurance
contracts contain embedded derivatives which are included in premiums and other receivables with changes in estimated fair value reported
in net investment gains (losses) or policyholder benefit and claims depending on the statement of operations classification of the direct risk.
The value of the embedded derivatives on the ceded risk is determined using a methodology consistent with that described previously for the
guarantees directly written by the Company.
The estimated fair value of the embedded derivatives within funds withheld at interest related to certain ceded reinsurance is determined
based on the change in estimated fair value of the underlying assets held by the Company in a reference portfolio backing the funds withheld
liability. The estimated fair value of the underlying assets is determined as described above in “Fixed Maturity Securities, Equity Securities and
Trading Securities” and “Short-term Investments.” The estimated fair value of these embedded derivatives is included, along with their funds
withheld hosts, in other liabilities with changes in estimated fair value recorded in net investment gains (losses). Changes in the credit spreads
F-67MetLife, Inc.
MetLife, Inc.
Notes to the Consolidated Financial Statements — (Continued)