Travelers 2007 Annual Report Download - page 177

THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Share-Based Compensation
The Company has an employee stock incentive compensation plan that permits grants of
nonqualified stock options, incentive stock options, stock appreciation rights, restricted stock, deferred
stock, stock units, performance awards and other stock-based or stock-denominated awards with respect
to the Company’s common stock.
Compensation cost is measured based on the grant-date fair value of an award, determined
pursuant to FAS 123R, Share-Based Payment, utilizing the assumptions discussed in note 11.
Compensation cost is recognized for financial reporting purposes over the period in which the
employee is required to provide service in exchange for the award (generally the vesting period).
Derivative Financial Instruments
The Company may use derivative financial instruments, including interest rate swaps, equity swaps,
credit derivatives, options, forward contracts and financial futures, as a means of hedging exposure to
interest rate, equity price change and foreign currency risk. The Company’s insurance subsidiaries do
not hold or issue derivative instruments for trading purposes. The Company recognizes all derivatives,
including certain derivative instruments embedded in other contracts, as either assets or liabilities in the
consolidated balance sheet and measures those instruments at fair value. Where applicable, hedge
accounting is used to account for derivatives. For an instrument to qualify as a hedge, the hedge
relationship must be designated and formally documented at inception, detailing the particular risk
management objective and strategy for the hedge, including the item and risk that is being hedged, the
derivative that is being used, and how effectiveness is being assessed. A derivative must be highly
effective in accomplishing the objective of offsetting either changes in fair value or cash flows for the
risk being hedged. The effectiveness of these hedging relationships is evaluated on a retrospective and
prospective basis using quantitative measures of correlation. If a hedge relationship is found to be
ineffective, it no longer qualifies as a hedge, and any excess gains or losses attributable to such
ineffectiveness as well as subsequent changes in fair value are recognized in net realized investment
gains (losses). The recognition of gains or losses on derivative instruments that have been designated
and qualify as a hedge depends upon whether the derivative instrument is a fair value hedge, a cash
flow hedge or a foreign currency hedge.
Derivatives that do not qualify for hedge accounting are carried at fair value with the changes in
fair value reflected in the consolidated statement of income in net realized investment gains (losses).
Nature of Operations
The Company is organized into three reportable business segments: Business Insurance, Financial,
Professional & International Insurance and Personal Insurance. These segments reflect the manner in
which the Company’s businesses are currently managed and represent an aggregation of products and
services based on type of customer, how the business is marketed and the manner in which risks are
underwritten.
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