The Hartford 2008 Annual Report Download - page 390

Table of Contents
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Fair Value Measurements (continued)
Determination of fair values
The valuation methodologies used to determine the fair values of assets and liabilities under the “exit price” notion of SFAS
157 reflect market-participant objectives and are based on the application of the fair value hierarchy that prioritizes
observable market inputs over unobservable inputs. The Company determines the fair values of certain financial assets and
financial liabilities based on quoted market prices, where available. The Company also determines fair value based on future
cash flows discounted at the appropriate current market rate. Fair values reflect adjustments for counterparty credit quality,
the Company’s credit standing, liquidity and, where appropriate, risk margins on unobservable parameters. The following is
a discussion of the methodologies used to determine fair values for the financial instruments listed in the above table.
Fixed Maturity, Short-Term, and Equity Securities, Available- for-Sale
The fair value of fixed maturity, short-term, and equity securities, available for sale, is determined by management after
considering one of three primary sources of information: third party pricing services, independent broker quotations, or
pricing matrices. Security pricing is applied using a “waterfall” approach whereby publicly available prices are first sought
from third party pricing services, the remaining unpriced securities are submitted to independent brokers for prices, or lastly,
securities are priced using a pricing matrix. Typical inputs used by these three pricing methods include, but are not limited
to, reported trades, benchmark yields, issuer spreads, bids, offers, and/or estimated cash flows and prepayments speeds.
Based on the typical trading volumes and the lack of quoted market prices for fixed maturities, third party pricing services
normally derive the security prices through recent reported trades for identical or similar securities making adjustments
through the reporting date based upon available market observable information outlined above. If there are no recent
reported trades, the third party pricing services and brokers may use matrix or model processes to develop a security price
where future cash flow expectations are developed based upon collateral performance and discounted at an estimated market
rate. Included in the pricing of ABS, collateralized mortgage obligations (“CMOs”), and mortgage-backed securities
(“MBS”) are estimates of the rate of future prepayments of principal over the remaining life of the securities. Such estimates
are derived based on the characteristics of the underlying structure and prepayment speeds previously experienced at the
interest rate levels projected for the underlying collateral. Actual prepayment experience may vary from these estimates.
Prices from third party pricing services are often unavailable for securities that are rarely traded or traded only in privately
negotiated transactions. As a result, certain securities are priced via independent broker quotations which utilize inputs that
may be difficult to corroborate with observable market based data. Additionally, the majority of these independent broker
quotations are non-binding. A pricing matrix is used to price securities for which the Company is unable to obtain either a
price from a third party pricing service or an independent broker quotation. The pricing matrix used by the Company begins
with current spread levels to determine the market price for the security. The credit spreads, as assigned by a knowledgeable
private placement broker, incorporate the issuer’s credit rating and a risk premium, if warranted, due to the issuer’s industry
and the security’s time to maturity. The issuer-specific yield adjustments, which can be positive or negative, are updated
twice per year, as of June 30 and December 31, by the private placement broker and are intended to adjust security prices for
issuer-specific factors. The Company assigns a credit rating to these securities based upon an internal analysis of the issuer’s
financial strength.
The Company performs a monthly analysis on the prices and credit spreads received from third parties to ensure that the
prices represent a reasonable estimate of the fair value. This process involves quantitative and qualitative analysis and is
overseen by investment and accounting professionals. Examples of procedures performed include, but are not limited to,
initial and on-going review of third party pricing services methodologies, review of pricing statistics and trends, back testing
recent trades and monitoring of trading volumes. In addition, the Company ensures whether prices received from
independent brokers represent a reasonable estimate of fair value through the use of internal and external cash flow models
developed based on spreads and, when available, market indices. As a result of this analysis, if the Company determines
there is a more appropriate fair value based upon the available market data, the price received from the third party is
adjusted accordingly. At December 31, 2008, the Company made fair value determinations which lowered prices received
from third party pricing services and brokers by a total of $139. The securities adjusted had an amortized cost and fair value
after adjustment, of $623 and $232, respectively, and were primarily CMBS securities.
In accordance with SFAS 157, the Company has analyzed the third party pricing services’ valuation methodologies and
related inputs, and has also evaluated the various types of securities in its investment portfolio to determine an appropriate
SFAS 157 fair value hierarchy level based upon trading activity and the observability of market inputs. Based on this
evaluation and investment class analysis, each price was classified into Level 1, 2 or 3. Most prices provided by third party
pricing services are classified into Level 2 because the inputs used in pricing the securities are market observable.
Due to a general lack of transparency in the process that the brokers use to develop prices, most valuations that are based on
brokers’ prices are classified as Level 3. Some valuations may be classified as Level 2 if the price can be corroborated.
Source: HARTFORD FINANCIAL S, 10-K, February 12, 2009