Travelers 2003 Annual Report Download - page 21

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19
Note 3 — Fair Value of Claims and Claim Adjustment Expense Reserves and Reinsurance
Recoverables
An adjustment has been applied to SPC's claims and claim adjustment expense reserves to estimate their fair value.
Since such reserves are not traded in a secondary market, the determination of a fair value is approximated by using
risk-adjusted present value techniques. Such techniques require application of significant judgment and assumptions.
The fair value adjustment that was applied included (1) discounting the reserves at risk-free rates of interest over an
assumed period of 30 years and (2) adding a risk factor that reflects the uncertainty within the reserves. Various
methodologies were considered to address the uncertainty in the reserves, including alternative measures of the
opportunity cost of capital and other underlying factors.
For purposes of the Unaudited Pro Forma Condensed Combined Income Statement, which assumes that the merger
was consummated on January 1, 2003, the range of risk-free rates of interest employed in the calculation was
approximately 1.2% to 4.9%, with a weighted average of 3.0% over an assumed payout period of 30 years and an
assumed average payout date of about 3.5 to 4.0 years. The fair value adjustment is being accreted in the pro forma
income statements over the period that the reserves are expected to remain outstanding, using an interest method that
locks in the initial interest rates by expected payment date.
For purposes of the Unaudited Pro Forma Condensed Combined Balance Sheet at December 31, 2003, the range of
risk-free rates of interest applied to the fair value adjustment was approximately 1.1% to 5.3%, with a weighted
average of 3.4% over an assumed payout period of 30 years and an assumed average payout date of about 3.5 to 4.0
years.
A similar methodology was applied to the related ceded reinsurance recoverables.
These estimates are subject to change, based on actual interest rates as of April 1, 2004 (the closing date of the merger)
and continuing refinement of the methodologies underlying risk factor development. As a result, the amount of the
final purchase accounting adjustment and subsequent accretion could differ materially from the amounts presented in
the preliminary unaudited pro forma condensed combined financial statements.