Travelers 2009 Annual Report Download - page 183

THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
present value with the amortized cost of the security. If the amortized cost is greater than the present
value of the expected cash flows, the difference is considered a credit loss and recognized in net
realized investment gains (losses).
For non-structured fixed maturities (U.S. Treasury securities, obligations of U.S. Government and
government agencies and authorities, obligations of states, municipalities and political subdivisions, debt
securities issued by foreign governments, and certain corporate debt), the estimate of expected cash
flows is determined by projecting a recovery value and a recovery time frame and assessing whether
further principal and interest will be received. The determination of recovery value incorporates an
issuer valuation assumption utilizing one or a combination of valuation methods as deemed appropriate
by the Company. The Company determines the undiscounted recovery value by allocating the estimated
value of the issuer to the Company’s assessment of the priority of claims. The present value of the cash
flows is determined by applying the effective yield of the security at the date of acquisition (or the most
recent implied rate used to accrete the security if the implied rate has changed as a result of a previous
impairment) and an estimated recovery time frame. Generally, that time frame for securities for which
the issuer is in bankruptcy is 12 months. For securities for which the issuer is financially troubled but
not in bankruptcy, that time frame is generally 24 months. Included in the present value calculation are
expected principal and interest payments; however, for securities for which the issuer is classified as
bankrupt or in default, the present value calculation assumes no interest payments and a single
recovery amount.
In estimating the recovery value, significant judgment is involved in the development of
assumptions relating to a myriad of factors related to the issuer including, but not limited to, revenue,
margin and earnings projections, the likely market or liquidation values of assets, potential additional
debt to be incurred pre- or post-bankruptcy/restructuring, the ability to shift existing or new debt to
different priority layers, the amount of restructuring/bankruptcy expenses, the size and priority of
unfunded pension obligations, litigation or other contingent claims, the treatment of intercompany
claims and the likely outcome with respect to inter-creditor conflicts.
For structured fixed maturity securities (primarily residential and commercial mortgage-backed
securities, collateralized mortgage obligations and pass-through securities), the Company estimates the
present value of the security by projecting future cash flows of the assets underlying the securitization,
allocating the flows to the various tranches based on the structure of the securitization, and
determining the present value of the cash flows using the effective yield of the security at the date of
acquisition (or the most recent implied rate used to accrete the security if the implied rate has changed
as a result of a previous impairment or changes in expected cash flows). The Company incorporates
levels of delinquencies, defaults and severities as well as credit attributes of the remaining assets in the
securitization, along with other economic data, to arrive at its best estimate of the parameters applied
to the assets underlying the securitization. In order to project cash flows, the following assumptions are
applied to the assets underlying the securitization: (1) voluntary prepayment rates, (2) default rates and
(3) loss severity. The key assumptions made for the Prime, Alt-A and Sub-Prime mortgage-backed
securities at December 31, 2009 were as follows:
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