The Hartford 2014 Annual Report Download - page 166

Table of Contents
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A pricing matrix is used to price private placement securities for which the Company is unable to obtain a price from a third-party pricing service by
discounting the expected future cash flows from the security by a developed market discount rate utilizing current credit spreads. Credit spreads are
developed each month using market based data for public securities adjusted for credit spread differentials between public and private securities which are
obtained from a survey of multiple private placement brokers. The appropriate credit spreads determined through this survey approach are based upon the
issuer’s financial strength and term to maturity, utilizing an independent public security index and trade information and adjusting for the non-public nature
of the securities.
The Securities Working Group performs ongoing analysis of the prices and credit spreads received from third parties to ensure that the prices represent a
reasonable estimate of the fair value. This process involves quantitative and qualitative analysis and is overseen by investment and accounting professionals.
As a part of this analysis, the Company considers trading volume, new issuance activity and other factors to determine whether the market activity is
significantly different than normal activity in an active market, and if so, whether transactions may not be orderly considering the weight of available
evidence. If the available evidence indicates that pricing is based upon transactions that are stale or not orderly, the Company places little, if any, weight on
the transaction price and will estimate fair value utilizing an internal pricing model. In addition, the Company ensures that prices received from independent
brokers represent a reasonable estimate of fair value through the use of internal and external cash flow models developed based on spreads, and when
available, market indices. As a result of this analysis, if the Company determines that there is a more appropriate fair value based upon the available market
data, the price received from the third party is adjusted accordingly and approved by the Valuation Committee. The Company’s internal pricing model
utilizes the Company’s best estimate of expected future cash flows discounted at a rate of return that a market participant would require. The significant
inputs to the model include, but are not limited to, current market inputs, such as credit loss assumptions, estimated prepayment speeds and market risk
premiums.
The Company conducts other specific monitoring controls around pricing. Daily analyses identify price changes over 3% for fixed maturities and 5% for
equity securities and trade prices that differ over 3% to the current day's price. Weekly analyses identify prices that differ more than 5% from published bond
prices of a corporate bond index. Monthly analyses identify price changes over 3%, prices that have not changed, and missing prices. Also on a monthly
basis, a second source validation is performed on most sectors. Analyses are conducted by a dedicated pricing unit that follows up with trading and
investment sector professionals and challenges prices with vendors when the estimated assumptions used differ from what the Company feels a market
participant would use. Any changes from the identified pricing source are verified by further confirmation of assumptions used. Examples of other procedures
performed include, but are not limited to, initial and on-going review of third-party pricing services’ methodologies, review of pricing statistics and trends,
and back testing recent trades.
The Company has analyzed the third-party pricing services’ valuation methodologies and related inputs, and has also evaluated the various types of
securities in its investment portfolio to determine an appropriate fair value hierarchy level based upon trading activity and the observability of market inputs.
Most prices provided by third-party pricing services are classified into Level 2 because the inputs used in pricing the securities are market observable. Due to
a general lack of transparency in the process that brokers use to develop prices, most valuations that are based on brokers’ prices are classified as Level 3.
Some valuations may be classified as Level 2 if the price can be corroborated with observable market data.
Derivative Instruments, including embedded derivatives within investments
Derivative instruments are fair valued using pricing valuation models for OTC derivatives that utilize independent market data inputs, quoted market prices
for exchange-traded and OTC-cleared derivatives, or independent broker quotations. Excluding embedded and reinsurance related derivatives, as of
December 31, 2014 and 2013, 96% and 97%, respectively, of derivatives, based upon notional values, were priced by valuation models or quoted market
prices. The remaining derivatives were priced by broker quotations.
The Derivatives Working Group performs ongoing analysis of the valuations, assumptions and methodologies used to ensure that the prices represent a
reasonable estimate of the fair value. The Company performs various controls on derivative valuations which include both quantitative and qualitative
analysis. Analyses are conducted by a dedicated derivative pricing team that works directly with investment sector professionals to analyze impacts of
changes in the market environment and investigate variances. There is a monthly analysis to identify market value changes greater than pre-defined
thresholds, stale prices, missing prices and zero prices. Also on a monthly basis, a second source validation, typically to broker quotations, is performed for
certain of the more complex derivatives, as well as for any existing deals with a market value greater than $10 and all new deals during the month. In
addition, on a daily basis, market valuations are compared to counterparty valuations for OTC derivatives. A model validation review is performed on any
new models, which typically includes detailed documentation and validation to a second source. The model validation documentation and results of
validation are presented to the Valuation Committee for approval. There is a monthly control to review changes in pricing sources to ensure that new models
are not moved to production until formally approved.
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