3 Fair Value
We have categorized our financial instruments, based on the degree of subjectivity inherent in the method by which they are valued, into a fair value hierarchy of three levels, as follows:
During 2009, we adopted the recently issued fair value guidance, pursuant to generally accepted accounting principles, that requires us to evaluate whether a market is distressed or inactive in determining the fair value for our portfolio. Based on this new guidance, we added to our review certain additional market level inputs to evaluate whether sufficient activity, volume, and new issuances existed to create an active market. Based on this evaluation, we concluded that there was sufficient activity related to the sectors and securities for which we obtained valuations.
The composition of the investment portfolio by major security type was:
(millions) | Fair Value | Cost | ||||||||
---|---|---|---|---|---|---|---|---|---|---|
Level 1 | Level 2 | Level 3 | Total | |||||||
December 31, 2009 |
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Fixed maturities: | ||||||||||
U.S. government obligations | $ | 4,817.5 | $ | — | $ | — | $ | 4,817.5 | $ | 4,939.6 |
State and local government obligations | — | 2,024.0 | — | 2,024.0 | 1,974.2 | |||||
Corporate and other debt securities | — | 1,253.2 | 29.3 | 1,282.5 | 1,246.0 | |||||
Subtotal | 4,817.5 | 3,277.2 | 29.3 | 8,124.0 | 8,159.8 | |||||
Asset-backed securities: | ||||||||||
Residential mortgage-backed | — | 470.3 | 46.1 | 516.4 | 592.0 | |||||
Commercial mortgage-backed | — | 1,568.5 | 21.6 | 1,590.1 | 1,572.0 | |||||
Other asset-backed | — | 718.4 | 7.8 | 726.2 | 721.9 | |||||
Subtotal asset-backed securities | — | 2,757.2 | 75.5 | 2,832.7 | 2,885.9 | |||||
Redeemable preferred stocks: | ||||||||||
Financials | 17.8 | 231.9 | — | 249.7 | 277.2 | |||||
Utilities | — | 66.9 | — | 66.9 | 69.4 | |||||
Industrials | — | 237.0 | 53.1 | 290.1 | 324.7 | |||||
Subtotal redeemable preferred stocks | 17.8 | 535.8 | 53.1 | 606.7 | 671.3 | |||||
Total fixed maturities | 4,835.3 | 6,570.2 | 157.9 | 11,563.4 | 11,717.0 | |||||
Equity securities: | ||||||||||
Nonredeemable preferred stocks: | ||||||||||
Financials | 604.2 | 534.2 | — | 1,138.4 | 561.6 | |||||
Utilities | — | 65.8 | — | 65.8 | 50.8 | |||||
Industrials | — | 51.6 | — | 51.6 | 53.0 | |||||
Subtotal nonredeemable preferred stocks | 604.2 | 651.6 | — | 1,255.8 | 665.4 | |||||
Common equities: | ||||||||||
Common stocks1 | 803.3 | — | — | 803.3 | 593.2 | |||||
Other risk investments | — | — | 12.9 | 12.9 | 5.2 | |||||
Subtotal common equities | 803.3 | — | 12.9 | 816.2 | 598.4 | |||||
$ | 6,242.8 | $ | 7,221.8 | $ | 170.8 | 13,635.4 | 12,980.8 | |||
Other short-term investments2 | 1,078.0 | 1,078.0 | ||||||||
Total portfolio | $ | 14,713.4 | $ | 14,058.8 | ||||||
Debt3 | $ | 2,154.2 | $ | 2,177.2 | ||||||
(millions) | Fair Value |
Cost | ||||||||
Level 1 | Level 2 | Level 3 | Total | |||||||
December 31, 2008 |
||||||||||
Fixed maturities: | ||||||||||
U.S. government obligations | $ | 3,693.6 | $ | — | $ | — | $ | 3,693.6 | $ | 3,565.7 |
State and local government obligations | — | 3,004.4 | — | 3,004.4 | 3,041.4 | |||||
Foreign government obligations | — | 16.4 | — | 16.4 | 16.2 | |||||
Corporate and other debt securities | — | 615.1 | 27.2 | 642.3 | 694.2 | |||||
Subtotal | 3,693.6 | 3,635.9 | 27.2 | 7,356.7 | 7,317.5 | |||||
Asset-backed securities: | ||||||||||
Residential mortgage-backed | — | 622.7 | .3 | 623.0 | 758.7 | |||||
Commercial mortgage-backed | — | 1,423.6 | 26.4 | 1,450.0 | 1,692.7 | |||||
Other asset-backed | — | 118.1 | 11.0 | 129.1 | 139.2 | |||||
Subtotal asset-backed securities | — | 2,164.4 | 37.7 | 2,202.1 | 2,590.6 | |||||
Redeemable preferred stocks: | ||||||||||
Financials | 12.1 | 155.7 | — | 167.8 | 166.1 | |||||
Utilities | — | 37.0 | — | 37.0 | 37.0 | |||||
Industrials | — | 138.4 | 44.7 | 183.1 | 184.1 | |||||
Subtotal redeemable preferred stocks | 12.1 | 331.1 | 44.7 | 387.9 | 387.2 | |||||
Total fixed maturities | 3,705.7 | 6,131.4 | 109.6 | 9,946.7 | 10,295.3 | |||||
Equity Securities: | ||||||||||
Nonredeemable preferred stocks: | ||||||||||
Agencies | — | 1.0 | — | 1.0 | 1.0 | |||||
Financials | 477.2 | 505.9 | — | 983.1 | 960.3 | |||||
Utilities | — | 53.6 | — | 53.6 | 54.5 | |||||
Industrials | — | — | 112.3 | 112.3 | 115.5 | |||||
Subtotal nonredeemable preferred stocks | 477.2 | 560.5 | 112.3 | 1,150.0 | 1,131.3 | |||||
Common equities: | ||||||||||
Common stocks1 | 714.3 | — | — | 714.3 | 547.8 | |||||
Other risk investments | — | — | 13.5 | 13.5 | 5.8 | |||||
Subtotal common equities | 714.3 | — | 13.5 | 727.8 | 553.6 | |||||
$ | 4,897.2 | $ | 6,691.9 | $ | 235.4 | 11,824.5 | 11,980.2 | |||
Other short-term investments2 | 1,153.6 | 1,153.6 | ||||||||
Total portfolio | $ | 12,978.1 | $ | 13,133.8 | ||||||
Debt3 | $ | 1,581.6 | $ | 2,175.5 |
1) Common stocks are managed externally to track the Russell 1000 Index. Therefore, a break-out by major sector type is not provided.
2) Due to the underlying nature of these securities, cost approximates fair value.
3) Debt is not subject to measurement at fair value in the Consolidated Balance Sheets. Therefore, it is not broken out by hierarchy level; fair values are obtained from publicly quoted sources.
Our portfolio valuations classified as either Level 1 or Level 2 in the above table are priced exclusively by external sources, including: pricing vendors, dealers/market makers, and exchange-quoted prices. With limited exceptions, our Level 3 securities are also priced externally; however, due to several factors (e.g., nature of the securities, level of activity, lack of similar securities trading to obtain observable market level inputs), these valuations are more subjective in nature. Certain private equity investments and fixed-income investments included in the Level 3 category are valued using external pricing supplemented by internal review and analysis.
At December 31, 2009, vendor-quoted prices represented approximately 77% of our Level 1 classifications, compared to 74% at December 31, 2008. The securities quoted by vendors in Level 1 represent holdings in our U.S. Treasury Notes, which are frequently traded and the quotes are considered similar to exchange trade quotes. The balance of our Level 1 pricing comes from quotes obtained directly from trades made on an active exchange. At December 31, 2009, vendor-quoted prices comprised 92% of our Level 2 classifications, compared to 97% at December 31, 2008. We reviewed independent documentation detailing the pricing techniques, models, and methodologies used by these pricing vendors and believe that their policies adequately consider market activity, either based on specific transactions for the issue valued or based on modeling of securities with similar credit quality, duration, yield, and structure that were recently transacted. We continue to monitor any changes or modifications to their processes. During 2009 and 2008, we reviewed each sector for transaction volumes and determined that sufficient activity and liquidity existed to provide a credible source for market level valuations.
At December 31, 2009, broker-quoted prices represented the remaining 8% of our Level 2 classifications, compared to 3% at December 31, 2008. In these instances, we typically use broker/dealers because the security we hold is not widely held or frequently traded and thus is not serviced by the pricing vendors. We reviewed independent documentation detailing the pricing techniques, models, and methodologies used by broker/dealers and determined that they used the same pricing techniques as the external vendor pricing sources discussed above. The broker/dealers contain back office pricing desks, separate from the day-to-day traders that buy and sell the securities. This process creates uniformity in pricing when they quote externally to their various customers. The broker/dealer valuations are quoted in terms of spreads to various indices and the spreads are based off recent transactions adjusted for movements since the last trade or based off similar characteristic securities currently trading in the market. These quotes are not considered binding offers to transact. From time to time, we will obtain more than one broker quote for a security, when we feel it is necessary. In addition, from time to time, we will receive a broker/dealer quote for those securities priced by vendors as further evaluation of market price. We believe this additional step helps to ensure that we are reporting the most representative price and validates our pricing methodology.
To the extent the inputs used by external pricers are determined to not contain sufficient observable market information, we will reclassify the affected security valuations to Level 3. At December 31, 2009 and 2008, securities in our fixed-maturity portfolio listed as Level 3 were comprised substantially of securities that were either: (i) private placement deals, (ii) thinly held and/or traded securities, or (iii) lower rated non-investment-grade securities, where little liquidity exists. Based on these factors, it was difficult to independently verify observable market inputs that were used to generate the external valuations we received. At December 31, 2009 and 2008, one private common equity security with an aggregate value of $10.2 million was priced internally.
During each valuation period, we create internal estimations of portfolio valuation (performance returns), based on current market-related activity (i.e., interest rate and credit spread movements and other credit-related factors) within each major sector of our portfolio. We compare our internally-generated portfolio results with those generated based on quotes we received externally and research material valuation differences to identify the appropriate fair value to report for these securities.
Based on the criteria described above, we believe that the current level classifications are appropriate based on the valuation techniques used and that our fair values accurately reflect current market assumptions in the aggregate.
The following tables provide a summary of changes in fair value associated with Level 3 assets for the years ended December 31, 2009 and 2008:
(millions) | Level 3 Fair Value | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Fair value at December 31, 2008 |
Calls/ Maturities/ Paydowns |
Purchases | Sales | Realized (gain)/loss |
Change in Valuation |
Transfers in (out)1 |
Fair value at December 31, 2009 |
|||||||||
Fixed maturities: | ||||||||||||||||
Asset-backed securities: | ||||||||||||||||
Residential mortgage-backed | $ | .3 | $ | (3.9) | $ | 49.4 | $ | — | $ | — | $ | .3 | $ | — | $ | 46.1 |
Commercial mortgage-backed | 26.4 | (.8) | — | (23.3) | 6.3 | 20.2 | (7.2) | 21.6 | ||||||||
Other asset-backed | 11.0 | (3.5) | 11.0 | — | — | .3 | (11.0) | 7.8 | ||||||||
Total asset-backed securities | 37.7 | (8.2) | 60.4 | (23.3) | 6.3 | 20.8 | (18.2) | 75.5 | ||||||||
Corporate debt securities | 27.2 | — | — | (1.1) | (1.8) | 5.0 | — | 29.3 | ||||||||
Redeemable preferred stocks – industrials | 44.7 | — | — | — | — | 8.4 | — | 53.1 | ||||||||
Total fixed maturities | 109.6 | (8.2) | 60.4 | (24.4) | 4.5 | 34.2 | (18.2) | 157.9 | ||||||||
Nonredeemable preferred stocks – Industrials | 112.3 | (15.2) | — | (99.8) | (.6) | 3.3 | — | — | ||||||||
Common equities – other risk investments | 13.5 | (.1) | — | — | — | (.5) | — | 12.9 | ||||||||
Total Level 3 securities | $ | 235.4 | $ | (23.5) | $ | 60.4 | $ | (124.2) | $ | 3.9 | $ | 37.0 | $ | (18.2) | $ | 170.8 |
1) Of the $18.2 million of transfers out of Level 3, $11.0 million was due to a privately placed other asset-backed security that was priced internally at acquisition. The security was transferred into the Level 2 category once pricing was provided by a vendor. The remaining $7.2 million transferred out of Level 3 and placed into the Level 2 category reflects changes in the inputs used to measure fair value during the period.
(millions) | Level 3 Fair Value | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Fair value at December 31, 2007 |
Calls/ Maturities/ Paydowns |
Purchases | Sales | Realized (gain)/loss |
Change in Valuation |
Transfers in (out)1 |
Fair value at December 31, 2008 |
|||||||||
Fixed maturities: | ||||||||||||||||
Asset-backed securities: | ||||||||||||||||
Residential mortgage-backed | $ | .5 | $ | (.1) | $ | — | $ | — | $ | — | $ | (.1) | $ | — | $ | .3 |
Commercial mortgage-backed | 58.4 | (3.1) | — | — | — | (30.5) | 1.6 | 26.4 | ||||||||
Other asset-backed | 30.6 | (3.9) | — | (14.3) | .5 | (1.9) | — | 11.0 | ||||||||
Total asset-backed securities | 89.5 | (7.1) | — | (14.3) | .5 | (32.5) | 1.6 | 37.7 | ||||||||
Corporate debt securities | 29.9 | — | — | — | — | (2.7) | — | 27.2 | ||||||||
Redeemable preferred stocks – industrials | — | — | — | — | — | — | 44.7 | 44.7 | ||||||||
Total fixed maturities | 119.4 | (7.1) | — | (14.3) | .5 | (35.2) | 46.3 | 109.6 | ||||||||
Nonredeemable preferred stocks – Industrials | 115.6 | — | — | — | — | (3.3) | — | 112.3 | ||||||||
Common equities – other risk investments | 13.7 | (.9) | — | — | — | .7 | — | 13.5 | ||||||||
Total Level 3 securities | $ | 248.7 | $ | (8.0) | $ | — | $ | (14.3) | $ | .5 | $ | (37.8) | $ | 46.3 | $ | 235.4 |
1) Represents securities transferred into Level 3 during 2008 due to infrequent trading and illiquidity.