Allstate 2008 Annual Report Download - page 123

Management’s Discussion and Analysis
of Financial Condition and Results of Operations–(Continued)
Fair Value of Financial Assets and Financial Liabilities Statement of Financial Accounting Standards
No. 157, Fair Value Measurements (‘‘SFAS No. 157’’), is effective for fiscal years beginning after November 15,
2007. We adopted the provisions of SFAS No. 157 as of January 1, 2008 for financial assets and financial liabilities
that are measured at fair value. SFAS No. 157:
●Defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date, and establishes a framework for
measuring fair value;
●Establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to
the valuation as of the measurement date;
●Expands disclosures about financial instruments measured at fair value.
We categorize our financial assets and financial liabilities measured at fair value based on the observability of
inputs to the valuation techniques, into a three-level fair value hierarchy as follows:
Level 1: Financial assets and financial liabilities whose values are based on unadjusted quoted prices for
identical assets or liabilities in an active market that we can access.
Level 2: Financial assets and financial liabilities whose values are based on the following:
(a) Quoted prices for similar assets or liabilities in active markets;
(b) Quoted prices for identical or similar assets or liabilities in non-active markets; or
(c) Valuation models whose inputs are observable, directly or indirectly, for substantially the full term of
the asset or liability.
Level 3: Financial assets and financial liabilities whose values are based on prices or valuation techniques that
require inputs that are both unobservable and significant to the overall fair value measurement. These
inputs may reflect our estimates of the assumptions that market participants would use in valuing the
financial assets and financial liabilities.
Observable inputs are those used by market participants in valuing financial instruments that are developed
based on market data obtained from independent sources. In the absence of sufficient observable inputs,
unobservable inputs reflect our estimates of the assumptions market participants would use in valuing financial
assets and financial liabilities and are developed based on the best information available in the circumstances.
The degree of management judgment involved in determining fair values is inversely related to the availability of
market observable information.
To distinguish among the categories, we consider the frequency of completed transactions such as daily
trading for equity securities. If inputs used to measure a financial instrument fall within different levels of the fair
value hierarchy, the categorization is based on the lowest level input that is significant to the fair value
measurement of the entire instrument. Certain financial assets are not carried at fair value on a recurring basis,
including investments such as mortgage loans, limited partnership interests, bank loans and policy loans.
Accordingly, such investments are only included in the fair value hierarchy disclosure when the investment is
subject to remeasurement at fair value after initial recognition and the resulting measurement is reflected in the
consolidated financial statements. In addition, equity options embedded in fixed income securities are not
disclosed in the hierarchy with free-standing derivatives, as the embedded derivatives are presented as combined
instruments in fixed income securities.
We are responsible for the determination of the value of the financial assets and financial liabilities carried at
fair value and the supporting assumptions and methodologies. We gain assurance on the overall reasonableness
and consistent application of valuation input assumptions, valuation methodologies and compliance with
accounting standards for fair value determination through the execution of various processes and controls
designed to ensure that our financial assets and financial liabilities are appropriately valued. We monitor fair
values received from third parties and those derived internally on an ongoing basis.
In certain situations, we employ independent third-party valuation service providers to gather, analyze, and
interpret market information and derive fair values based upon relevant assumptions and methodologies for
individual instruments. In situations where our valuation service providers are unable to obtain sufficient market
observable information upon which to estimate the fair value for a particular security, fair value is determined
either by requesting brokers who are knowledgeable about these securities to provide a single quote or by
employing internal valuation models that are widely accepted in the financial services industry. Changing market
conditions are incorporated into valuation assumptions and reflected in the fair values, which are validated by
calibration and other analytical techniques to available market observable data.
Valuation service providers typically obtain data about market transactions and other key valuation model
inputs from multiple sources and, through the use of proprietary algorithms, produce valuation information in the
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MD&A