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Fair Value
 9 Months Ended
Sep. 30, 2012
Fair Value Disclosures [Abstract]  
Fair Value
Note F. Fair Value
Fair value is the price that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The following fair value hierarchy is used in selecting inputs, with the highest priority given to Level 1, as these are the most transparent or reliable.
Level 1 - Quoted prices for identical instruments in active markets.
Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs are observable in active markets.
Level 3 - Valuations derived from valuation techniques in which one or more significant inputs are not observable.
Prices may fall within Level 1, 2 or 3 depending upon the methodologies and inputs used to estimate fair value for each specific security. Prices are determined by a dedicated group who ultimately report to the Company's CFO. This group is responsible for valuation policies and procedures. In general the Company seeks to price securities using third-party pricing services. Securities not priced by pricing services are submitted to independent brokers for valuation and, if those are not available, internally developed pricing models are used to value assets using methodologies and inputs the Company believes market participants would use to value the assets.
The Company performs control procedures over information obtained from pricing services and brokers to ensure prices received represent a reasonable estimate of fair value and to confirm representations regarding whether inputs are observable or unobservable. Procedures include i) the review of pricing service or broker pricing methodologies, ii) back-testing, where past fair value estimates are compared to actual transactions executed in the market on similar dates, iii) exception reporting, where changes in price, period-over-period, are reviewed and challenged with the pricing service or broker based on exception criteria, iv) deep dives, where the Company independently validates detailed information regarding inputs and assumptions for individual securities and v) pricing validation, where prices received are compared to prices independently estimated by the Company.
Assets and Liabilities Measured at Fair Value
Assets and liabilities measured at fair value on a recurring basis are summarized below.
September 30, 2012
 
 
 
 
 
 
Total
Assets/(Liabilities)
at Fair Value
(In millions)
Level 1
 
Level 2
 
Level 3
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Corporate and other bonds
$
—

 
$
21,569

 
$
259

 
$
21,828

States, municipalities and political subdivisions
—

 
10,723

 
89

 
10,812

Asset-backed:
 
 
 
 
 
 
 
Residential mortgage-backed
—

 
5,653

 
437

 
6,090

Commercial mortgage-backed
—

 
1,571

 
117

 
1,688

Other asset-backed
—

 
595

 
371

 
966

Total asset-backed
—

 
7,819

 
925

 
8,744

U.S. Treasury and obligations of government-sponsored enterprises
168

 
24

 
—

 
192

Foreign government
139

 
475

 
—

 
614

Redeemable preferred stock
29

 
60

 
26

 
115

Total fixed maturity securities
336

 
40,670

 
1,299

 
42,305

Equity securities
98

 
112

 
50

 
260

Derivative and other financial instruments, included in Other invested assets
—

 
—

 
11

 
11

Short term investments
1,209

 
1,223

 
8

 
2,440

Life settlement contracts, included in Other assets
—

 
—

 
113

 
113

Separate account business
4

 
338

 
3

 
345

Total assets
$
1,647

 
$
42,343

 
$
1,484

 
$
45,474

Liabilities


 
 
 


 


Derivative financial instruments, included in Other liabilities
$
—

 
$
(2
)
 
$
(1
)
 
$
(3
)
Total liabilities
$
—

 
$
(2
)
 
$
(1
)
 
$
(3
)
December 31, 2011
 
 
 
 
 
 
Total
Assets/(Liabilities)
at Fair Value
(In millions)
Level 1
 
Level 2
 
Level 3
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Corporate and other bonds
$
—

 
$
20,402

 
$
482

 
$
20,884

States, municipalities and political subdivisions
—

 
9,611

 
171

 
9,782

Asset-backed:
 
 
 
 
 
 
 
Residential mortgage-backed
—

 
5,323

 
452

 
5,775

Commercial mortgage-backed
—

 
1,295

 
59

 
1,354

Other asset-backed
—

 
612

 
343

 
955

Total asset-backed
—

 
7,230

 
854

 
8,084

U.S. Treasury and obligations of government-sponsored enterprises
451

 
42

 
—

 
493

Foreign government
92

 
544

 
—

 
636

Redeemable preferred stock
5

 
53

 
—

 
58

Total fixed maturity securities
548

 
37,882

 
1,507

 
39,937

Equity securities
124

 
113

 
67

 
304

Derivative and other financial instruments, included in Other invested assets
—

 
1

 
11

 
12

Short term investments
1,106

 
508

 
27

 
1,641

Life settlement contracts, included in Other assets
—

 
—

 
117

 
117

Separate account business
21

 
373

 
23

 
417

Total assets
$
1,799

 
$
38,877

 
$
1,752

 
$
42,428

Liabilities
 
 
 
 
 
 
 
Derivative financial instruments, included in Other liabilities
$
—

 
$
—

 
$
(1
)
 
$
(1
)
Total liabilities
$
—

 
$
—

 
$
(1
)
 
$
(1
)
The tables below present a reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended September 30, 2012 and 2011.
Level 3
(In millions)
Balance at
July 1,
2012
 
Net realized investment gains (losses) and net change in unrealized appreciation (depreciation) included in net income (loss)*
 
Net change in unrealized appreciation (depreciation) included in other comprehensive income (loss)
 
Purchases
 
Sales
 
Settlements
 
Transfers into
Level 3
 
Transfers out
of Level 3
 
Balance at
September 30,
2012
 
Unrealized gains (losses) on Level 3 assets and liabilities held at September 30, 2012 recognized in net income (loss)*
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
488

 
$
1

 
$
(4
)
 
$
50

 
$
(5
)
 
$
(11
)
 
$
—

 
$
(260
)
 
$
259

 
$
(1
)
States, municipalities and political subdivisions
89

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
89

 
—

Asset-backed:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


 
 
Residential mortgage-backed
443

 
(17
)
 
20

 
21

 
—

 
(8
)
 
—

 
(22
)
 
437

 
(18
)
Commercial mortgage-backed
166

 
4

 
6

 
12

 
—

 
(17
)
 
11

 
(65
)
 
117

 
—

Other asset-backed
434

 
2

 
5

 
143

 
(117
)
 
(34
)
 
—

 
(62
)
 
371

 
—

Total asset-backed
1,043

 
(11
)
 
31

 
176

 
(117
)
 
(59
)
 
11

 
(149
)
 
925

 
(18
)
Redeemable preferred stock
27

 
—

 
(1
)
 
—

 
—

 
—

 
—

 
—

 
26

 
—

Total fixed maturity securities
1,647

 
(10
)
 
26

 
226

 
(122
)
 
(70
)
 
11

 
(409
)
 
1,299

 
(19
)
Equity securities
93

 
(19
)
 
(10
)
 
—

 
—

 
—

 
—

 
(14
)
 
50

 
(19
)
Derivative and other financial instruments, net
10

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
10

 
—

Short term investments
4

 
—

 
—

 
7

 
(4
)
 
—

 
1

 
—

 
8

 
—

Life settlement contracts
116

 
7

 
—

 
—

 
—

 
(10
)
 
—

 
—

 
113

 
—

Separate account business
3

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
3

 
—

Total
$
1,873

 
$
(22
)
 
$
16

 
$
233

 
$
(126
)
 
$
(80
)
 
$
12

 
$
(423
)
 
$
1,483

 
$
(38
)
Level 3
(In millions)
Balance at
July 1,
2011
 
Net realized investment gains (losses) and net change in unrealized appreciation (depreciation) included in net income (loss)*
 
Net change in unrealized appreciation (depreciation) included in other comprehensive income (loss)
 
Purchases
 
Sales
 
Settlements
 
Transfers into
Level 3
 
Transfers out
of Level 3
 
Balance at
September 30,
2011
 
Unrealized gains (losses) on Level 3 assets and liabilities held at September 30, 2011 recognized in net income (loss)*
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
812

 
$
(7
)
 
$
(3
)
 
$
113

 
$
(107
)
 
$
(47
)
 
$
12

 
$
(154
)
 
$
619

 
$
(10
)
States, municipalities and political subdivisions
179

 
—

 
—

 
3

 
—

 
—

 
—

 
—

 
182

 
—

Asset-backed:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


 
 
Residential mortgage-backed
687

 
1

 
(5
)
 
73

 
(81
)
 
(13
)
 
—

 
(31
)
 
631

 
—

Commercial mortgage-backed
95

 
—

 
(7
)
 
76

 
—

 
—

 
—

 
(5
)
 
159

 
—

Other asset-backed
491

 
(5
)
 
(6
)
 
114

 
(105
)
 
(25
)
 
2

 
(37
)
 
429

 
(4
)
Total asset-backed
1,273

 
(4
)
 
(18
)
 
263

 
(186
)
 
(38
)
 
2

 
(73
)
 
1,219

 
(4
)
Total fixed maturity securities
2,264

 
(11
)
 
(21
)
 
379

 
(293
)
 
(85
)
 
14

 
(227
)
 
2,020

 
(14
)
Equity securities
36

 
—

 
—

 
—

 
(1
)
 
—

 
—

 
(3
)
 
32

 
—

Derivative and other financial instruments, net
9

 
(1
)
 
—

 
1

 
—

 
—

 
—

 
—

 
9

 
—

Short term investments
6

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
6

 
—

Life settlement contracts
129

 
11

 
—

 
—

 
—

 
(15
)
 
—

 
—

 
125

 
(1
)
Separate account business
37

 
—

 
—

 
—

 
(2
)
 
—

 
—

 
—

 
35

 
—

Total
$
2,481

 
$
(1
)
 
$
(21
)
 
$
380

 
$
(296
)
 
$
(100
)
 
$
14

 
$
(230
)
 
$
2,227

 
$
(15
)
The tables below present a reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2012 and 2011.
Level 3
(In millions)
Balance at
January 1,
2012
 
Net realized investment gains (losses) and net change in unrealized appreciation (depreciation) included in net income (loss)*
 
Net change in unrealized appreciation (depreciation) included in other comprehensive income (loss)
 
Purchases
 
Sales
 
Settlements
 
Transfers into
Level 3
 
Transfers out
of Level 3
 
Balance at
September 30,
2012
 
Unrealized gains (losses) on Level 3 assets and liabilities held at September 30, 2012 recognized in net income (loss)*
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
482

 
$
7

 
$
2

 
$
197

 
$
(118
)
 
$
(43
)
 
$
42

 
$
(310
)
 
$
259

 
$
(1
)
States, municipalities and political subdivisions
171

 
—

 
3

 
—

 
—

 
(85
)
 
—

 
—

 
89

 
—

Asset-backed:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
452

 
(15
)
 
(2
)
 
81

 
—

 
(24
)
 
—

 
(55
)
 
437

 
(18
)
Commercial mortgage-backed
59

 
6

 
14

 
141

 
(12
)
 
(21
)
 
11

 
(81
)
 
117

 
—

Other asset-backed
343

 
8

 
8

 
501

 
(293
)
 
(93
)
 
—

 
(103
)
 
371

 
—

Total asset-backed
854

 
(1
)
 
20

 
723

 
(305
)
 
(138
)
 
11

 
(239
)
 
925

 
(18
)
Redeemable preferred stock
—

 
—

 
(1
)
 
53

 
(26
)
 
—

 
—

 
—

 
26

 
—

Total fixed maturity securities
1,507

 
6

 
24

 
973

 
(449
)
 
(266
)
 
53

 
(549
)
 
1,299

 
(19
)
Equity securities
67

 
(19
)
 
6

 
26

 
(16
)
 
—

 
—

 
(14
)
 
50

 
(21
)
Derivative and other financial instruments, net
10

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
10

 
—

Short term investments
27

 
—

 
—

 
23

 
(4
)
 
(39
)
 
1

 
—

 
8

 
—

Life settlement contracts
117

 
30

 
—

 
—

 
—

 
(34
)
 
—

 
—

 
113

 
3

Separate account business
23

 
—

 
—

 
—

 
(20
)
 
—

 
—

 
—

 
3

 
—

Total
$
1,751

 
$
17

 
$
30

 
$
1,022

 
$
(489
)
 
$
(339
)
 
$
54

 
$
(563
)
 
$
1,483

 
$
(37
)

Level 3
(In millions)
Balance at
January 1,
2011
 
Net realized investment gains (losses) and net change in unrealized appreciation (depreciation) included in net income (loss)*
 
Net change in unrealized appreciation (depreciation) included in other comprehensive income (loss)
 
Purchases
 
Sales
 
Settlements
 
Transfers into
Level 3
 
Transfers out
of Level 3
 
Balance at
September 30,
2011
 
Unrealized gains (losses) on Level 3 assets and liabilities held at September 30, 2011 recognized in net income (loss)*
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
624

 
$
(5
)
 
$
(6
)
 
$
459

 
$
(157
)
 
$
(144
)
 
$
52

 
$
(204
)
 
$
619

 
$
(11
)
States, municipalities and political subdivisions
266

 
—

 
—

 
3

 
—

 
(87
)
 
—

 
—

 
182

 
—

Asset-backed:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
767

 
(11
)
 
9

 
170

 
(164
)
 
(54
)
 
—

 
(86
)
 
631

 
(15
)
Commercial mortgage-backed
73

 
3

 
11

 
81

 
(4
)
 
—

 
—

 
(5
)
 
159

 
—

Other asset-backed
359

 
—

 
(6
)
 
441

 
(236
)
 
(80
)
 
2

 
(51
)
 
429

 
(4
)
Total asset-backed
1,199

 
(8
)
 
14

 
692

 
(404
)
 
(134
)
 
2

 
(142
)
 
1,219

 
(19
)
Redeemable preferred stock
3

 
3

 
(3
)
 
—

 
(3
)
 
—

 
—

 
—

 
—

 
—

Total fixed maturity securities
2,092

 
(10
)
 
5

 
1,154

 
(564
)
 
(365
)
 
54

 
(346
)
 
2,020

 
(30
)
Equity securities
26

 
(2
)
 
(1
)
 
19

 
(12
)
 
—

 
5

 
(3
)
 
32

 
(3
)
Derivative and other financial instruments, net
25

 
2

 
—

 
1

 
(19
)
 
—

 
—

 
—

 
9

 
1

Short term investments
27

 
—

 
—

 
12

 
—

 
(23
)
 
—

 
(10
)
 
6

 
—

Life settlement contracts
129

 
20

 
—

 
—

 
—

 
(24
)
 
—

 
—

 
125

 
2

Separate account business
41

 
—

 
—

 
—

 
(6
)
 
—

 
—

 
—

 
35

 
—

Total
$
2,340

 
$
10

 
$
4

 
$
1,186

 
$
(601
)
 
$
(412
)
 
$
59

 
$
(359
)
 
$
2,227

 
$
(30
)

* Net realized and unrealized gains and losses shown above are reported in Net income (loss) as follows:
Major Category of Assets and Liabilities
 
Consolidated Statements of Operations Line Items
Fixed maturity securities available-for-sale
 
Net realized investment gains (losses)
Fixed maturity securities trading
 
Net investment income
Equity securities
 
Net realized investment gains (losses)
Derivative financial instruments held in a trading portfolio
 
Net investment income
Derivative financial instruments not held in a trading portfolio and fair value option financial instruments
 
Net realized investment gains (losses)
Life settlement contracts
 
Other revenues
Securities shown in the Level 3 tables on the previous pages may be transferred in or out of Level 3 based on the availability of observable market information used to determine the fair value of the security. The availability of observable market information varies based on market conditions and trading volume and may cause securities to move in and out of Level 3 from reporting period to reporting period. There were $106 million of transfers from Level 2 to Level 1 during the three and nine months ended September 30, 2012 and no transfers between Level 1 and Level 2 during the three or nine months ended September 30, 2011. The Company's policy is to recognize transfers between levels at the beginning of quarterly reporting periods.
Valuation Methodologies and Inputs
The following section describes the valuation methodologies and relevant inputs used to measure different financial instruments at fair value, including an indication of the level in the fair value hierarchy in which the instruments are generally classified.
Fixed Maturity Securities
Fixed maturity securities are valued using methodologies that model information generated by market transactions involving identical or comparable assets, as well as discounted cash flow methodologies. Common inputs include: prices from recently executed transactions of similar securities, broker/dealer quotes, benchmark yields, spreads off benchmark yields, interest rates and U.S. Treasury or swap curves. Specifically for asset-backed securities, key inputs include prepayment and default projections based on past performance of the underlying collateral and current market data.
Level 1 securities include highly liquid U.S. and foreign government bonds, and redeemable preferred stock, valued using quoted market prices. Level 2 securities include most other fixed maturity securities as the significant inputs are observable in the marketplace. Securities are generally assigned to Level 3 in cases where broker/dealer quotes are significant inputs to the valuation and there is a lack of transparency as to whether these quotes are based on information that is observable in the marketplace. Level 3 securities also include tax-exempt auction rate certificates and private placement debt securities. Fair value of auction rate securities is determined utilizing a pricing model with three primary inputs. The interest rate and spread inputs are observable from like instruments while the expected call date assumption is unobservable due to the uncertain nature of principal prepayments prior to maturity. Fair value of private placement debt securities is determined using internal models with inputs that are not market observable.
Equity Securities
Level 1 equity securities include publicly traded securities valued using quoted market prices. Level 2 securities are primarily non-redeemable preferred stocks and common stocks valued using pricing for similar securities, recently executed transactions, broker/dealer quotes and other pricing models utilizing market observable inputs. Level 3 securities are priced using internal models with inputs that are not market observable.
Derivative and Other Financial Instruments
Exchange traded derivatives, primarily futures, are valued using quoted market prices and are classified within Level 1 of the fair value hierarchy. Level 2 derivatives primarily include currency forwards valued using observable market forward rates. Over-the-counter derivatives, principally interest rate swaps, total return swaps, credit default swaps, equity warrants and options, are valued using inputs including broker/dealer quotes and are classified within Level 3 of the valuation hierarchy due to a lack of transparency as to whether these quotes are based on information that is observable in the marketplace. Other financial instruments consist of Level 3 securities for which the fair value option has been elected which contain embedded derivatives and are priced using either broker/dealer quotes or internal models with inputs that are not market observable.
Short Term Investments
The valuation of securities that are actively traded or have quoted prices are classified as Level 1. These securities include money market funds and treasury bills. Level 2 primarily includes commercial paper, for which all inputs are market observable. Fixed maturity securities purchased within one year of maturity are classified consistent with fixed maturity securities discussed above. Short term investments as presented in the tables above differ from the amounts presented on the Condensed Consolidated Balance Sheets because certain short term investments, such as time deposits, are not measured at fair value.
Life Settlement Contracts
The fair values of life settlement contracts are determined as the present value of the anticipated death benefits less anticipated premium payments based on contract terms that are distinct for each insured, as well as the Company's own assumptions for mortality, premium expense and the rate of return that a buyer would require on the contracts, as no comparable market pricing data is available.
Separate Account Business
Separate account business includes fixed maturity securities, equities and short term investments. The valuation methodologies and inputs for these asset types have been described above.
Significant Unobservable Inputs
The table below presents quantitative information about the significant unobservable inputs utilized by the Company in the fair value measurements of Level 3 assets. Valuations for assets and liabilities not presented in the table below are primarily based on broker/dealer quotes for which there is a lack of transparency as to inputs used to develop the valuations. The quantitative detail of these unobservable inputs is neither provided nor reasonably available to the Company.
 
Fair Value at September 30, 2012
 
Valuation Technique(s)
 
Unobservable Input(s)
 
Range
 (Weighted Average)
Assets
 
 
 
 
 
 
 
(In millions)
 
 
 
 
 
 
 
Fixed maturity securities
$
98

 
Discounted cash flow
 
Expected call date
 
3.6 - 5.6 years (4.6 years)
 
$
61

 
Market approach
 
Private offering price
 
$60.00 - $105.00 ($101.49)
Equity securities
$
33

 
Market approach
 
Private offering price
 
$0.10 - $3,842.00 per share
($583.95 per share)
 
$
17

 
Income approach
 
EBITDA projection (1)
 
$80 million
 
 
 
 
 
EBITDA multiple (1)
 
1.82
Life settlement contracts
$
113

 
Discounted cash flow
 
Discount rate risk premium
 
9%
 
 
 
 
 
Mortality assumption
 
65% - 928% (185%)
(1) Earnings before interest, tax, depreciation and amortization 
For fixed maturity securities, an increase to the expected call date assumption or decrease in the private offering price would result in a lower fair value measurement. For equity securities, an increase in the private offering price, earnings projections and earnings multiples would result in a higher fair value measurement. For life settlement contracts, an increase in the discount rate risk premium or decrease in the mortality assumption would result in a lower fair value measurement.
Financial Assets and Liabilities Not Measured at Fair Value
The carrying amount and estimated fair value of the Company's financial instrument assets and liabilities which are not measured at fair value on the Condensed Consolidated Balance Sheets are listed in the tables below.
September 30, 2012
Carrying
Amount
 
Estimated Fair Value
(In millions)
 
Level 1
 
Level 2
 
Level 3
 
Total
Financial assets
 
 
 
 
 
 
 
 
 
Notes receivable for the issuance of common stock
$
21

 
$
—

 
$
—

 
$
21

 
$
21

Mortgage loans
358

 
—

 
—

 
374

 
374

Financial liabilities
 
 
 
 
 
 
 
 
 
Premium deposits and annuity contracts
$
103

 
$
—

 
$
—

 
$
108

 
$
108

Short term debt
13

 
—

 
13

 
—

 
13

Long term debt
2,557

 
—

 
2,986

 
—

 
2,986


December 31, 2011
Carrying
Amount
 
Estimated
Fair Value
(In millions)
 
Financial assets
 
 
 
Notes receivable for the issuance of common stock
$
22

 
$
22

Mortgage loans
234

 
247

Financial liabilities
 
 
 
Premium deposits and annuity contracts
$
109

 
$
114

Short term debt
83

 
84

Long term debt
2,525

 
2,679


The following methods and assumptions were used to estimate the fair value of these financial assets and liabilities.
The fair values of Notes receivable for the issuance of common stock were estimated using discounted cash flows utilizing interest rates currently offered for obligations securitized with similar collateral, adjusted for specific note receivable risk.
The fair values of Mortgage loans were based on the present value of the expected future cash flows discounted at the current interest rate for origination of similar quality loans, adjusted for specific loan risk.
Premium deposits and annuity contracts were valued based on cash surrender values or estimated fair values of policyholder liabilities, net of amounts ceded related to sold business.
The Company's senior notes and debentures were valued based on observable market prices. The fair value for other debt was estimated using discounted cash flows based on current incremental borrowing rates for similar borrowing arrangements.
The carrying amounts reported on the Condensed Consolidated Balance Sheets for Cash, Short term investments not carried at fair value, Accrued investment income and certain other assets and other liabilities approximate fair value due to the short term nature of these items. These assets and liabilities are not listed in the tables above.