Travelers 2006 Annual Report Download - page 154

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Interest Rate Risk
In this sensitivity analysis model, the Company uses fair values to measure its potential loss. The
sensitivity analysis model includes the following financial instruments entered into for purposes other than
trading: fixed maturities, non-redeemable preferred stocks, mortgage loans, short-term securities, debt and
derivative financial instruments. The primary market risk to the Company’s market sensitive instruments is
interest rate risk. The sensitivity analysis modeluses a 100 basis point change in interest rates to measure
the hypothetical change in fair value of financial instruments included in the model.
For invested assets with primary exposure to interest rate risk, estimates of portfolio duration and
convexity are used to model the loss of fair value that would be expected to result from a parallel increase
in interest rates. Durations on invested assets are adjusted for call, put and interest rate reset features.
Durations ontax-exempt securities are adjusted for the fact that the yields on such securities do not
normally move in lockstep with changes in the U.S. Treasury curve. Fixed maturity portfolio durations are
calculated on a market value weighted basis, includingaccrued interest, using holdings as of December 31,
2006 and 2005.
For debt, the change in fair value is determined by calculating hypothetical December 31, 2006 and
2005 ending prices based on yields adjusted to reflect a 100 basis point change, comparing such
hypothetical ending prices to actual endingprices, and multiplying the difference by the par or securities
outstanding.
The sensitivity analysis model used by the Company produces a loss in fair value of market sensitive
instruments of approximately $2.3 billion and $2.2 billion based on a 100 basis point increase in interest
rates as of December 31, 2006 and 2005, respectively.
The loss estimates do not take into account the impact of possible interventions that the Company
might reasonably undertake in order to mitigate or avoidlosses that would result from emerging interest
rate trends. In addition, the loss value only reflects the impact of an interest rate increase on the fair value
of the Company’s financial instruments. As a result, the loss value excludes a significant portion of the
Company’s consolidated balance sheet, which if included in the sensitivity analysis model, would mitigate
the impact of the loss in fair value associated with a 100 basis point increase in interest rates.
Foreign Currency Exchange Rate Risk
The Company uses fair values of investmentsecurities to measure its potential loss from foreign
denominated investments. A hypothetical 10% reduction in value offoreign denominated investments is
used to estimate the impact on the market value of the foreign denominated holdings. The potential loss is
reduced by foreign currency forward transactions that are used to hedge a portion of the Company’s
exposure to foreign currencies. The Company’s analysis indicates that a hypothetical 10% reduction in the
value of foreign denominated investments would be expected to produce a loss in fair value of
approximately $438million and $374 million at December 31, 2006 and 2005, respectively.