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Unum 2010 Annual Report
29
Fair values for derivatives other than embedded derivatives in modified coinsurance arrangements are based on market quotes or
pricing models and represent the net amount of cash we would have paid or received if the contracts had been settled or closed as of the
last day of the period. We analyze credit default swap spreads relative to the average credit spread embedded within the London Interbank
Offered Rate (LIBOR) setting syndicate in determining the effect of credit risk on our derivatives’ fair values. If counterparty credit risk for a
derivative asset is determined to be material and is not adequately reected in the LIBOR-based fair value obtained from our pricing
sources, we adjust the valuations obtained from our pricing sources. In regard to our own credit risk component, we adjust the valuation of
derivative liabilities wherein the counterparty is exposed to our credit risk when the LIBOR-based valuation of our derivatives obtained from
pricing sources does not effectively include an adequate credit component for our own credit risk.
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 signicant assumptions which may or may not reect those of an active market.
As of December 31, 2010, 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 2.01 percent for ve-year maturities to 4.33 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 2.68 percent for five-year maturities to
4.64 percent for 30-year maturities used at December 31, 2009.
• Current Baa corporate bond spreads ranging from 1.31 percent to 1.95 percent plus an additional 20 basis points were added to the
risk free rate to reect the lack of liquidity. We used spreads ranging from 1.60 percent to 2.00 percent plus an additional 20 basis
points at December 31, 2009. 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, 2009.
• 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, 2010 fair value of these types of securities by
approximately $0.5 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, 2010, approximately 13.5 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 86.5 percent of our fixed maturity securities were valued based on non-binding quotes or other observable or
unobservable inputs, as discussed below.