Travelers 2010 Annual Report Download - page 155

Investment Valuation and Impairments
Fair Value Measurements
The Company’s estimates of fair value for financial assets and financial liabilities are based on the
framework established in the fair value accounting guidance. The framework is based on the inputs
used in valuation, gives the highest priority to quoted prices in active markets, and requires that
observable inputs be used in the valuations when available. The disclosure of fair value estimates in the
fair value accounting guidance hierarchy is based on whether the significant inputs into the 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 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 used 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
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