Fair Value and Financial Instruments

6 Months Ended

Jun. 30, 2011

Fair Value and Financial Instruments

Fair Value and Financial Instruments

15.  Fair Value and Financial Instruments

Accounting standards establish a three tier fair value hierarchy which prioritizes the inputs used in measuring fair values as follows:

· Level 1 — observable inputs such as quoted prices for identical assets in active markets;

· Level 2 — inputs other than quoted prices for identical assets in active markets, that are observable either directly or indirectly; and

· Level 3 — unobservable inputs in which there is little or no market data which requires the use of valuation techniques and the development of assumptions.

The following methods and assumptions are used to estimate the fair values of the Company’s financial instruments:

Money market funds and highly liquid debt securities are carried at cost and amortized cost, respectively, as an approximation of fair value.  Based on market convention, the Company considers cost a practical and expedient measure of fair value.

Fixed maturity investments are carried at fair value, which is based on quoted market prices or on estimated values if they are not actively traded.  In some cases where a market price is not available, the Company will make use of acceptable expedients (such as matrix pricing) to estimate fair value.

Derivatives are carried at fair value, based upon industry standard valuation techniques that use, where possible, current market-based or independently sourced pricing inputs, such as interest rates, currency exchange rates, or implied volatilities.

Debt is carried at outstanding principal balance, less any unamortized discount or premium.   Fair value is based on quoted market prices or estimates using discounted cash flow analyses based on current borrowing rates for similar types of borrowing arrangements.

The following tables present the categorization of the Company’s assets and liabilities that are measured at fair value on a recurring basis at June 30, 2011 and December 31, 2010 (in millions):

			Fair Value Measurements Using
			Quoted Prices in		Significant		Significant
			Active Markets		Other		Unobservable
	Balance at		for Identical		Observable		Inputs
	June 30, 2011		Assets (Level 1)		Inputs (Level 2)		(Level 3)
Assets:
Money market funds and highly liquid debt securities (1)	$	2,974	$	2,924	$	50	$	—
Other investments
Fixed maturity securities
Corporate bonds	12		—		—		12
Government bonds	3		—		3		—
Derivatives
Interest rate contracts	13		—		13		—
Foreign exchange contracts	110		—		110		—
Liabilities:
Derivatives
Foreign exchange contracts	156		—		156		—

(1)  Includes $2,924 million of money market funds and $50 million of highly liquid debt securities that are classified as fiduciary assets, short-term investments or cash equivalents in the condensed consolidated statements of financial position, depending on their nature and initial maturity.  See Note 8 “Investments” for additional information regarding the Company’s investments.

			Fair Value Measurements Using
			Quoted Prices in		Significant		Significant
			Active Markets		Other		Unobservable
	Balance at		for Identical		Observable		Inputs
	December 31, 2010		Assets (Level 1)		Inputs (Level 2)		(Level 3)
Assets:
Money market funds and highly liquid debt securities (1)	$	2,618	$	2,591	$	27	$	—
Other investments
Fixed maturity securities
Corporate bonds	12		—		—		12
Government bonds	3		—		3		—
Derivatives
Interest rate contracts	15		—		15		—
Foreign exchange contracts	159		—		159		—
Liabilities:
Derivatives
Foreign exchange contracts	158		—		158		—

(1)  Includes $2,591 million of money market funds and $27 million of highly liquid debt securities that are classified as fiduciary assets, short-term investments or cash equivalents in the condensed consolidated statements of financial position, depending on their nature and initial maturity.  See Note 8 “Investments” for additional information regarding the Company’s investments.

The following table presents the changes in the Level 3 fair-value category (in millions):

	Three months ended June 30,				Six months ended June 30,
	2011		2010		2011		2010
	Other Investments		Other Investments		Other Investments		Other Investments
Balance at beginning of period	$	12	$	11	$	12	$	100
Total gains (losses):
Included in earnings	—		—		—		—
Included in other comprehensive income	—		—		—		(1		)
Purchases	—		10		—		9
Transfers (1)	—		—		—		(87		)
Balance at end of period	$	12	$	21	$	12	$	21

(1) Transfers represent the removal of the investment in PEPS I preferred stock as a result of consolidating PEPS I on January 1, 2010.

There are no realized or unrealized gains or losses related to assets and liabilities measured at fair value using level three inputs included in income for either the three or six months ended June 30, 2011.

The following table discloses the Company’s financial instruments where the carrying amounts and fair values differ (in millions):

	June 30, 2011				December 31, 2010
	Carrying		Fair		Carrying		Fair
	Value		Value		Value		Value
Long-term debt	$	4,479	$	4,700	$	4,014	$	4,172