Unum 2011 Annual Report Download - page 33

Unum 2011 Annual Report
Unum
2011
31
• Underlying collateral
• Prepayment speeds/loan performance/delinquencies/weighted average life/seasoning
• Public covenants
• Comparative bond analysis
• Derivative spreads
• Relevant reports issued by analysts and rating agencies
• Audited financial statements
We review all prices obtained to ensure they are consistent with a variety of observable market inputs and to verify the validity of a
security’s price. In the event we receive a vendor’s market price that does not appear reasonable based on our market analysis, we may
challenge the price and request further information about the assumptions and methodologies used by the vendor to price the security. We
may change the vendor price based on a better data source such as an actual trade. We also review all price changes from the prior month
which fall outside a predetermined corridor. The overall valuation process for determining fair values may include adjustments to valuations
obtained from our pricing sources when they do not represent a valid exit price. These adjustments may be made when, in our judgment
and considering our knowledge of the financial conditions and industry in which the issuer operates, certain features of the financial
instrument require that an adjustment be made to the value originally obtained from our pricing sources. These features may include the
complexity of the financial instrument, the market in which the financial instrument is traded, counterparty credit risk, credit structure,
concentration, or liquidity. Additionally, an adjustment to the price derived from a model typically reflects our judgment of the inputs that
other participants in the market for the financial instrument being measured at fair value would consider in pricing that same financial
instrument. In the event that we sell an asset, we test the validity of the fair value determined by our valuation techniques by comparing
the selling price to the fair value determined for the asset in the immediately preceding reporting period or prior month end closest to the
transaction date. Historically, our realized gain or loss on disposition of an investment is consistent with the assumptions under the
valuation methodologies described above, which, combined with the results of our testing, indicates to us that our pricing methodologies
are appropriate.
The parameters and inputs used to validate a price on a security may be adjusted for assumptions about risk and current market
conditions on a quarter to quarter basis, as certain features may be more significant drivers of valuation at the time of pricing. Changes to
inputs in valuations are not changes to valuation methodologies; rather, the inputs are modified to reflect direct or indirect impacts on asset
classes from changes in market conditions.
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 reflected 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 significant assumptions which may or may not reflect those of an active market.