Travelers 2012 Annual Report Download - page 163

asset class and the market conditions. Depending on the security, the priority of the use of inputs may
change or some market inputs may not be relevant. For some securities, additional inputs may be
necessary.
The pricing service utilized by the Company has indicated that they will only produce an estimate
of fair value if there is objectively verifiable information to produce a valuation. If the pricing service
discontinues pricing an investment, the Company would be required to produce an estimate of fair
value using some of the same methodologies as the pricing service but would have to make
assumptions for market-based inputs that are unavailable due to market conditions.
The fair value estimates of most fixed maturity investments are based on observable market
information rather than market quotes. Accordingly, the estimates of fair value for such fixed
maturities, other than U.S. Treasury securities, provided by the pricing service are included in the
amount disclosed in Level 2 of the hierarchy. The estimated fair value of U.S. Treasury securities is
included in the amount disclosed in Level 1 as the estimates are based on unadjusted market prices.
The Company reviews the estimates of fair value provided by the pricing service and compares the
estimates to the Company’s knowledge of the market to determine if the estimates obtained are
representative of the prices in the market. In addition, the Company has periodic discussions with the
pricing service to discuss any changes in their process and reactions to overall markets. The Company
produces a report monthly that lists all price changes from the previous month in excess of 10%. The
Company reviews the report and will challenge any prices deemed not to be representative of fair
value. In addition, the Company has implemented various other processes including randomly selecting
purchased or sold securities and comparing execution prices to the estimates from the pricing service as
well as reviewing reports that contain securities whose valuation did not change from their previous
valuation (stale price review). The Company also uses an additional independent pricing service to
further test the primary pricing service’s valuation of the Company’s fixed maturity portfolio. These
processes have not highlighted any significant issues with the fair value estimates received from the
pricing service.
The Company also holds certain fixed maturity investments which are not priced by the pricing
service and, accordingly, estimates the fair value of such fixed maturities using an internal matrix that is
based on market information regarding interest rates, credit spreads and liquidity. The underlying
source data for calculating the matrix of credit spreads relative to the U.S. Treasury curve are the BofA
Merrill Lynch U.S. Corporate Index and the BofA Merrill Lynch BB U.S. High Yield Index. The
Company includes the fair value estimates of these corporate bonds in Level 2, since all significant
inputs are market observable.
While the vast majority of the Company’s municipal bonds and corporate bonds are included in
Level 2, the Company holds a number of municipal bonds and corporate bonds which are not valued
by the pricing service and, accordingly, estimates the fair value of these bonds using an internal pricing
matrix with some unobservable inputs that are significant to the valuation. Due to the limited amount
of observable market information, the Company includes the fair value estimates for these particular
bonds in Level 3. The fair value of the fixed maturities for which the Company used an internal pricing
matrix was $102 million and $88 million at December 31, 2012 and 2011, respectively. Additionally, the
Company holds a small amount of other fixed maturity investments that have characteristics that make
them unsuitable for matrix pricing. For these fixed maturities, the Company obtains a quote from a
broker (primarily the market maker). The fair value of the fixed maturities for which the Company
received a broker quote was $128 million and $162 million at December 31, 2012 and 2011,
respectively. Due to the disclaimers on the quotes that indicate that the price is indicative only, the
Company includes these fair value estimates in Level 3.
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