Travelers 2008 Annual Report Download - page 155

valuation are observable. In determining the level of the hierarchy in which the estimate is disclosed,
the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to
unobservable inputs that reflect the Company’s significant market assumptions. The three levels of the
hierarchy are as follows:
— Level 1—Unadjusted quoted market prices for identical assets or liabilities in active markets
that the Company has the ability to access.
— Level 2—Quoted prices for similar assets or liabilities in active markets; quoted prices for
identical or similar assets or liabilities in inactive markets; or valuations based on models
where the significant inputs are observable (e.g., interest rates, yield curves, prepayment
speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.
— Level 3—Valuations based on models where significant inputs are not observable. The
unobservable inputs reflect the Company’s own assumptions about the inputs that market
participants would use.
Valuation of Investments Reported at Fair Value in Financial Statements
The fair value of a financial instrument is the estimated amount at which the instrument could be
exchanged in an orderly transaction between knowledgeable, unrelated willing parties, i.e., not in a
forced transaction. The estimated fair value of a financial instrument may differ from the amount that
could be realized if the security was sold in an immediate sale, e.g., a forced transaction. Additionally,
the valuation of fixed maturity investments is more subjective when markets are less liquid due to the
lack of market based inputs, which may increase the potential that the estimated fair value (i.e., the
carrying amount) of an investment is not reflective of the price at which an actual transaction would
occur.
For investments that have quoted market prices in active markets, the Company uses the quoted
market prices as fair value and includes these prices in the amounts disclosed in Level 1 of the
hierarchy. The Company receives the quoted market prices from a third party, nationally recognized
pricing service (pricing service). When quoted market prices are unavailable, the Company utilizes a
pricing service to determine an estimate of fair value, which is mainly for its fixed maturity investments.
The fair value estimates provided from this pricing service are included in the amount disclosed in
Level 2 of the hierarchy. If quoted market prices and an estimate from a pricing service are
unavailable, the Company produces an estimate of fair value based on internally developed valuation
techniques, which, depending on the level of observable market inputs, will render the fair value
estimate as Level 2 or Level 3. The Company bases all of its estimates of fair value for assets on the
bid price as it represents what a third party market participant would be willing to pay in an arm’s
length transaction.
Fixed Maturities
The Company utilizes a pricing service to estimate fair value measurements for approximately 99%
of its fixed maturities. The pricing service utilizes market quotations for fixed maturity securities that
have quoted prices in active markets. Since fixed maturities other than U.S. Treasury securities
generally do not trade on a daily basis, the pricing service prepares estimates of fair value
measurements for these securities using its proprietary pricing applications which include available
relevant market information, benchmark curves, benchmarking of like securities, sector groupings, and
matrix pricing. Additionally, the pricing service uses an Option Adjusted Spread model to develop
prepayment and interest rate scenarios.
The pricing service evaluates each asset class based on relevant market information, relevant credit
information, perceived market movements and sector news. The market inputs utilized in the pricing
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