Unum 2009 Annual Report Download - page 35

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Unum 2009 Annual Report
Fair values for our embedded derivative in a modified coinsurance arrangement are estimated using internal pricing models and
represent the hypothetical value of the duration mismatch of assets and liabilities, interest rate risk, and third party credit risk embedded
in the modified coinsurance arrangement.
Certain of our investments do not have readily determinable market prices and/or observable inputs or may at times be affected by
the lack of market liquidity. For these securities, we use internally prepared valuations combining matrix pricing with vendor purchased
software programs, including valuations based on estimates of future profitability, to estimate the fair value. Additionally, we may obtain
prices from independent third-party brokers to aid in establishing valuations for certain of these securities. Key assumptions used by us to
determine fair value for these securities include risk free interest rates, risk premiums, performance of underlying collateral (if any), and
other factors involving significant assumptions which may or may not reflect those of an active market.
As of December 31, 2009, the key assumptions we generally used to estimate the fair value of these types of securities included
those listed below. Where appropriate, we have noted the assumption used for the prior period as well as the reason for the change.
• Risk free interest rates of 2.68 percent for ve-year maturities to 4.64 percent for 30-year maturities were derived from the current
yield curve for U.S. Treasury Bonds with similar maturities. This compares to interest rates of 1.55 percent for five-year maturities to
2.68 percent for 30-year maturities used at December 31, 2008.
• Current Baa corporate bond spreads ranging from 1.60 percent to 2.00 percent plus an additional 20 basis points were added to the
risk free rate to reflect the lack of liquidity. We used spreads ranging from 5.28 percent to 7.75 percent plus an additional 20 basis
points at December 31, 2008. The changes were based on observable market spreads. Newly issued private placement securities
have historically offered yield premiums of 20 basis points over comparable newly issued public securities.
• An additional ve basis points were added to the risk free rates for foreign investments, consistent with December 31, 2008.
• Additional basis points were added as deemed appropriate for certain industries and for individual securities in certain industries
that are considered to be of greater risk.
Increasing the 20 basis points added to the risk free rate for lack of liquidity by one basis point, increasing the five basis points added
to the risk free rates for foreign investments by one basis point, and increasing the additional basis points added to each industry considered
to be of greater risk by one basis point would have decreased the December 31, 2009 fair value of our fixed maturity securities portfolio by
approximately $0.6 million. We believe this range of variability is appropriate, and historically the inputs noted have generally not deviated
outside the range provided.
We regularly test the validity of the fair values determined by our valuation techniques by comparing the prices of assets sold to the
fair values reported for the assets in the immediately preceding reporting period. Historically, our realized gains or losses on dispositions
of investments have not varied significantly from amounts estimated under the valuation methodologies described above, which,
combined with the results of our testing, indicates to us that our pricing methodologies are appropriate.
At December 31, 2009, approximately 11.6 percent of our fixed maturity securities were valued using active trades from TRACE pricing,
or broker market maker prices for which there was current market activity in that specific security (comparable to receiving one binding
quote). The prices obtained were not adjusted, and the assets were classified as Level 1, the highest category of the three-level fair value
hierarchy classification wherein inputs are unadjusted and represent quoted prices in active markets for identical assets or liabilities.
The remaining 88.4 percent of our fixed maturity securities were valued based on non-binding quotes or other observable or
unobservable inputs, as discussed below.
• Approximately 72.7 percent of our xed maturity securities were valued based on prices from pricing services that generally use
observable inputs such as prices for securities or comparable securities in active markets in their valuation techniques. These assets
were classified as Level 2. Level 2 assets or liabilities are those valued using inputs (other than prices included in Level 1) that are
either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and
for the duration of the instrument’s anticipated life.
• Approximately 5.8 percent of our xed maturity securities were valued based on one or more non-binding broker price levels, if
validated by observable market data, or on TRACE prices for identical or similar assets absent current market activity. When only
one price is available, it is used if observable inputs and analysis confirm that it is appropriate. These assets, for which we were
able to validate the price using other observable market data, were classified as Level 2.