Mercury Insurance 2008 Annual Report Download - page 76

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66
The availability of observable inputs varies by instrument. In situations where fair value is based on internally developed
pricing models or inputs that are unobservable in the market, the determination of fair value requires more judgment. The degree
of judgment exercised by the Company in determining fair value is typically greatest for instruments categorized in Level 3. In
certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level
in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest
level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a
particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or
liability.
The Company uses prices and inputs that are current as of the measurement date, including during periods of market
disruption. In periods of market disruption, the ability to observe prices and inputs may be reduced for many instruments. This
condition could cause an instrument to be reclassified from Level 1 to Level 2, or from Level 2 to Level 3.
Summary of Significant Valuation Techniques for Financial Assets and Financial Liabilities
The Company primarily utilizes independent pricing services to obtain fair values on its portfolio except for 1% of its
portfolio at fair value where unadjusted broker quotes are obtained and less than 1% for which management performed discounted
cash flow modeling.
Level 1 Measurements
U.S. government bonds and agencies: U.S. treasuries and agencies are priced using unadjusted quoted market prices for identical
assets in active markets.
Common stock; Other: Comprised of actively traded, exchange listed U.S. and international equity securities and valued based on
unadjusted quoted prices for identical assets in active markets.
Short-term investments: Comprised of actively traded short-term bonds and money market funds that have daily quoted net asset
values for identical assets.
Derivative contracts: Comprised of free-standing exchange listed derivatives that are actively traded and valued based on quoted
prices for identical instruments in active markets.
Level 2 Measurements
Municipal securities: Municipal bonds are valued based on models or matrices using inputs including quoted prices for identical
or similar assets in active markets.
Mortgage-backed securities: Valued based on models or matrices using multiple observable inputs, such as benchmark yields,
reported trades and broker/dealer quotes, for identical or similar assets in active markets.
Corporate securities: Valued based on a multi-dimensional model using multiple observable inputs, such as benchmark yields,
reported trades, broker/dealer quotes and issue spreads, for identical or similar assets in active markets.
Redeemable and Non-redeemable preferred stock: Valued based on observable inputs, such as underlying and common stock of
same issuer and appropriate spread over a comparable U.S. Treasury security, for identical or similar assets in active markets.
Derivative contracts; Notes payable: Comprised of interest rate swaps that are valued based on models using inputs, such as
interest rate yield curves, observable for substantially the full term of the contract.
Level 3 Measurements
Municipal securities: Comprised of certain distressed municipal securities for which valuation is based on models that are widely
accepted in the financial services industry and require projections of future cash flows that are not market observable. Included in
this category are $3.0 million of auction rate securities (“ARS”). ARS are valued based on a discounted cash flow model with
certain inputs that are significant to the valuation, but are not market observable.
The Company’s total financial instruments at fair value are reflected in the consolidated balance sheets on a trade-date
basis. Related unrealized gains or losses are recognized in net realized investment gains and losses in the consolidated statements
of operations. Fair value measurements are not adjusted for transaction costs.