5. FAIR VALUE MEASUREMENTS

We determine the fair values of our debt, derivative, perpetual and privately issued equity securities primarily using three pricing approaches or techniques: quoted market prices readily available from public exchange markets, a discounted cash flow (DCF) pricing model, and price quotes we obtain from outside brokers.

Our DCF pricing model incorporates an option adjusted spread and utilizes various market inputs we obtain from both active and inactive markets. The estimated fair values developed by the DCF pricing model is most sensitive to prevailing credit spreads, the level of interest rates (yields) and interest rate volatility. Prior to March 31, 2010, credit spreads were derived based on pricing data obtained from investment brokers and took into account the current yield curve, time to maturity and subordination levels for similar securities or classes of securities. Subsequent to March 31, 2010, credit spreads were derived from using a bond index to create a credit spread matrix which takes into account the current credit spread, ratings and remaining time to maturity, and subordination levels for securities that are included in the bond index. Our DCF pricing model is based on a widely used global bond index that is comprised of investments in active markets. The index provides a broad-based measure of the global fixed-income bond market. This bond index covers bonds issued by European and American issuers, which account for the majority of bonds that we hold. We validate the reliability of the DCF pricing model periodically by using the model to price investments for which there are quoted market prices from active and inactive markets or, in the alternative, are quoted by our custodian for the same or similar securities.

The pricing data and market quotes we obtain from outside sources are reviewed internally for reasonableness. If a fair value appears unreasonable, the inputs are re-examined and the value is confirmed or revised.

In recent years, on the price quotes we obtain from outside brokers, we have noted a continued reduction in the availability of pricing data from this source. As a result, we have noted that available pricing data has become more volatile. The reduction in available pricing sources coupled with the increase in price volatility has increased the degree of management judgment required in the final determination of fair values. We assess the reasonableness of the pricing data we receive by comparing it to relevant market indices and other performance measurements.

Fair Value Hierarchy

GAAP specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. These two types of inputs create three valuation hierarchy levels. Level 1 valuations reflect quoted market prices for identical assets or liabilities in active markets. Level 2 valuations reflect quoted market prices for similar assets or liabilities in an active market, quoted market prices for identical or similar assets or liabilities in non-active markets or model-derived valuations in which all significant valuation inputs are observable in active markets. Level 3 valuations reflect valuations in which one or more of the significant valuation inputs are not observable in an active market. The vast majority of our financial instruments subject to the classification provisions of GAAP relate to our investment securities classified as securities available for sale in our investment portfolio. We determine the fair value of our securities available for sale using several sources or techniques based on the type and nature of the investment securities.

The following tables present the fair value hierarchy levels of the Company’s assets and liabilities that are measured at fair value on a recurring basis.


	June 30, 2011
(In millions)	Level 1		Level 2		Level 3		Total
Assets:
Fixed maturities:
Government and agencies	$	19,189	$	678	$	0	$	19,867
Municipalities		0		1,025		0		1,025
Mortgage- and asset-backed securities		0		1,241		257		1,498
Public utilities		0		5,584		0		5,584
Collateralized debt obligations		0		0		4		4
Sovereign and supranational		0		2,277		0		2,277
Banks/financial institutions		0		7,518		398		7,916
Other corporate		0		14,335		0		14,335
Total fixed maturities		19,189		32,658		659		52,506
Perpetual securities:
Banks/financial institutions		0		6,746		0		6,746
Other corporate		0		357		0		357
Total perpetual securities		0		7,103		0		7,103
Equity securities		14		5		4		23
Other assets:
Interest rate swaps		0		125		0		125
Foreign currency swaps		0		150		220		370
Total other assets		0		275		220		495
Total assets	$	19,203	$	40,041	$	883	$	60,127

Liabilities:
Interest rate swaps	$	0	$	5	$	0	$	5
Foreign currency swaps		0		270		56		326
Credit default swaps		0		0		253		253
Total liabilities	$	0	$	275	$	309	$	584


	December 31, 2010
(In millions)	Level 1		Level 2		Level 3		Total
Assets:
Fixed maturities:
Government and agencies	$	16,534	$	679	$	0	$	17,213
Municipalities		0		973		0		973
Mortgage- and asset-backed securities		0		1,539		267		1,806
Public utilities		0		5,369		0		5,369
Collateralized debt obligations		0		0		5		5
Sovereign and supranational		0		1,394		0		1,394
Banks/financial institutions		0		8,047		386		8,433
Other corporate		0		13,162		0		13,162
Total fixed maturities		16,534		31,163		658		48,355
Perpetual securities:
Banks/financial institutions		0		7,169		0		7,169
Other corporate		0		343		0		343
Total perpetual securities		0		7,512		0		7,512
Equity securities		14		5		4		23
Other assets:
Interest rate swaps		0		124		0		124
Foreign currency swaps		0		151		289		440
Total other assets		0		275		289		564
Total assets	$	16,548	$	38,955	$	951	$	56,454

Liabilities:
Interest rate swaps	$	0	$	70	$	0	$	70
Foreign currency swaps		0		280		48		328
Credit default swaps		0		0		343		343
Total liabilities	$	0	$	350	$	391	$	741

Approximately 45% of our fixed income and perpetual investments classified as Level 2 are valued by obtaining quoted market prices from our investment custodian. The custodian obtains price quotes from various pricing services that estimate fair values based on observable market transactions for similar investments in active markets, market transactions for the same investments in inactive markets or other observable market data where available.

The fair value of approximately 51% of our Level 2 fixed income and perpetual investments is determined using our DCF pricing model. The significant valuation inputs to the DCF model are obtained from, or corroborated by, observable market sources from both active and inactive markets.

For the remaining Level 2 investments that are not quoted by our custodian and cannot be priced under the DCF pricing model, we obtain specific broker quotes from up to three outside securities brokers and generally use the average of the quotes to estimate the fair value of the securities.

We use derivative instruments to manage the risk associated with certain assets. However, the derivative instrument may not be classified with the same fair value hierarchy as the associated asset. Derivative instruments are reported in Level 2 of the fair value hierarchy, except CDSs and certain foreign currency swaps which are classified as Level 3.

The interest rate and certain foreign currency derivative instruments classified as Level 2 were priced by broker quotations using inputs that are observable in the market. Inputs used to value derivatives include, but are not limited to, interest rates, foreign currency forward and spot rates, and interest volatility. For derivatives associated with any of our VIEs where we are the primary beneficiary, we are not the direct counterparty to the swap contracts. As a result, the fair value measurements provided by the broker incorporate the credit risk of the collateral associated with the VIE and counterparty credit risk.

The fair value of our interest rate swap contracts associated with our variable interest rate yen-denominated debt is based on the amount we would expect to receive or pay to terminate the swaps. The prices used to determine the value of the swaps are obtained from the respective swap counterparties and take into account current interest rates, duration and credit risk.

The fixed maturities, perpetual securities and derivatives classified as Level 3 consist of securities for which there are limited or no observable valuation inputs. We estimate the fair value of these securities by obtaining broker quotes from a limited number of brokers. These brokers base their quotes on a combination of their knowledge of the current pricing environment and market conditions. We consider these inputs unobservable. The equity securities classified in Level 3 are related to investments in Japanese businesses, each of which are insignificant and in the aggregate are immaterial. Because fair values for these investments are not readily available, we carry them at their original cost. We review each of these investments periodically and, in the event we determine that any are other-than-temporarily impaired, we write them down to their estimated fair value at that time.

Historically, we have not adjusted the quotes or prices we obtain from the brokers and pricing services we use.

The following tables present the changes in our available-for-sale investments and derivatives classified as Level 3.


Three Months Ended June 30, 2011
	Fixed Maturities															Perpetual Securities		Equity Securities		Derivatives
(In millions)	Mortgage- and Asset- Backed Securities			Public Utilities		Collateralized Debt Obligations			Sovereign and Supranational		Banks/ Financial Institutions			Other Corporate		Banks/ Financial Institutions				Foreign Currency Swaps		Credit Default Swaps			Total

Balance, beginning of period	$	248		$	0	$	5		$	0	$	420		$	0	$	0	$	4	$	126	$	(338	)	$	465
Realized gains or losses included in earnings		0			0		(1	)		0		0			0		0		0		25		(43	)		(19	)
Unrealized gains or losses included in other comprehensive income		12			0		0			0		(22	)		0		0		0		13		0			3
Purchases, issuances, sales and settlements:
Purchases		0			0		0			0		0			0		0		0		0		0			0
Issuances		0			0		0			0		0			0		0		0		0		0			0
Sales		0			0		0			0		0			0		0		0		0		0			0
Settlements		(3	)		0		0			0		0			0		0		0		0		128			125
Transfers into Level 3		0			0		0			0		0			0		0		0		0		0			0
Transfers out of Level 3		0			0		0			0		0			0		0		0		0		0			0

Balance, end of period	$	257		$	0	$	4		$	0	$	398		$	0	$	0	$	4	$	164	$	(253	)	$	574

Change in unrealized gains (losses) still held⁽¹⁾	$	0		$	0	$	(1	)	$	0	$	0		$	0	$	0	$	0	$	25	$	(7	)	$	17

⁽¹⁾

Represents the amount of total gains or losses for the period, included in earnings, attributable to the change in unrealized gains (losses) relating to assets classified as Level 3 that were still held at June 30, 2011


Three Months Ended June 30, 2010
	Fixed Maturities																	Perpetual Securities			Equity Securities			Derivatives
(In millions)	Mortgage- and asset- backed securities			Public utilities			Collateralized debt obligations		Sovereign and supranational			Banks/ financial institutions			Other corporate			Banks/ financial institutions						Credit default swaps			Total

Balance, beginning of period	$	63		$	488		$	4	$	298		$	1,103		$	1,253		$	1,695		$	9		$	(291	)	$	4,622
Realized gains or losses included in earnings		0			0			0		0			0			0			125			0			(66	)		59
Unrealized gains or losses included in other comprehensive income		1			0			0		0			1			1			(125	)		0			0			(122	)
Purchases, issuances, sales and settlements:
Purchases		0			0			0		0			0			0			0			0			0			0
Issuances		0			0			0		0			0			0			0			0			0			0
Sales		(1	)		(2	)		0		0			0			0			(531	)		0			0			(534	)
Settlements		0			0			0		0			0			0			0			0			0			0
Transfers into Level 3⁽¹⁾		219			0			0		0			330			0			0			0			0			549
Transfers out of Level 3⁽²⁾		0			(459	)		0		(298	)		(1,082	)		(1,202	)		(1,164	)		(5	)		0			(4,210	)

Balance, end of period	$	282		$	27		$	4	$	0		$	352		$	52		$	0		$	4		$	(357	)	$	364

Change in unrealized gains (losses) still held⁽³⁾	$	0		$	0		$	0	$	0		$	0		$	0		$	0		$	0		$	(66	)	$	(66	)

⁽¹⁾

Due to a lack of visibility to observe significant inputs to price and credit downgrades of respective issuers of securities to below investment grade

⁽²⁾

A result of changing our pricing methodology to using a pricing index for estimating fair value instead of obtaining pricing of the securities from brokers or arrangers

⁽³⁾


Six Months Ended June 30, 2011
	Fixed Maturities														Perpetual Securities		Equity Securities		Derivatives
(In millions)	Mortgage- and Asset- Backed Securities			Public Utilities		Collateralized Debt Obligations			Sovereign and Supranational		Banks/ Financial Institutions		Other Corporate		Banks/ Financial Institutions				Foreign Currency Swaps			Credit Default Swaps			Total

Balance, beginning of period	$	267		$	0	$	5		$	0	$	386	$	0	$	0	$	4	$	241		$	(343	)	$	560
Realized gains or losses included in earnings		(6	)		0		(1	)		0		1		0		0		0		(39	)		(38	)		(83	)
Unrealized gains or losses included in other comprehensive income		2			0		0			0		11		0		0		0		(38	)		0			(25	)
Purchases, issuances, sales and settlements:
Purchases		0			0		0			0		0		0		0		0		0			0			0
Issuances		0			0		0			0		0		0		0		0		0			0			0
Sales		0			0		0			0		0		0		0		0		0			0			0
Settlements		(6	)		0		0			0		0		0		0		0		0			128			122
Transfers into Level 3		0			0		0			0		0		0		0		0		0			0			0
Transfers out of Level 3		0			0		0			0		0		0		0		0		0			0			0

Balance, end of period	$	257		$	0	$	4		$	0	$	398	$	0	$	0	$	4	$	164		$	(253	)	$	574

Change in unrealized gains (losses) still held⁽¹⁾	$	(6	)	$	0	$	(1	)	$	0	$	1	$	0	$	0	$	0	$	(39	)	$	(15	)	$	(60	)

⁽¹⁾


Six Months Ended June 30, 2010
	Fixed Maturities																		Perpetual Securities			Equity Securities			Derivatives
(In millions)	Mortgage- and asset- backed securities			Public utilities			Collateralized debt obligations			Sovereign and supranational			Banks/ financial institutions			Other corporate			Banks/ financial institutions						Credit default swaps			Total

Balance, beginning of period	$	62		$	497		$	267		$	293		$	1,240		$	1,248		$	1,441		$	9		$	0		$	5,057
Effect of change in accounting principle ⁽¹⁾		0			0			(263	)		0			0			0			0			0			(312	)		(575	)
Revised balance, beginning of period		62			497			4			293			1,240			1,248			1,441			9			(312	)		4,482
Realized gains or losses included in earnings		0			0			0			0			5			0			108			0			(45	)		68
Unrealized gains or losses included in other comprehensive income		2			(9	)		0			5			34			6			51			0			0			89
Purchases, issuances, sales and settlements:
Purchases		0			0			0			0			0			0			0			0			0			0
Issuances		0			0			0			0			0			0			0			0			0			0
Sales		(1	)		(2	)		0			0			(175	)		0			(585	)		0			0			(763	)
Settlements		0			0			0			0			0			0			0			0			0			0
Transfers into Level 3⁽²⁾		219			0			0			0			330			0			149			0			0			698
Transfers out of Level 3⁽³⁾		0			(459	)		0			(298	)		(1,082	)		(1,202	)		(1,164	)		(5	)		0			(4,210	)

Balance, end of period	$	282		$	27		$	4		$	0		$	352		$	52		$	0		$	4		$	(357	)	$	364

Change in unrealized gains (losses) still held⁽⁴⁾	$	0		$	0		$	0		$	0		$	0		$	0		$	0		$	0		$	(45	)	$	(45	)

⁽¹⁾

Change in accounting for VIEs effective January 1, 2010. See Notes 1, 3, and 4 for additional information.

⁽²⁾

Due to a lack of visibility to observe significant inputs to price and credit downgrades of respective issuers of securities to below investment grade

⁽³⁾

A result of changing our pricing methodology to using a pricing index for estimating fair value instead of obtaining pricing of the securities from brokers or arrangers

⁽⁴⁾

As discussed in Notes 1 and 3, we adopted new accounting guidance on VIEs effective January 1, 2010, and as a result have consolidated certain VIE investments. Upon consolidation, the beneficial interest was derecognized and the underlying securities and derivatives were recognized. In many cases, the fair value hierarchy level differed between the original beneficial interest asset and the underlying securities that are now being recognized. In the Level 3 rollforward, we have separately disclosed the impact of consolidating these VIE investments that were previously categorized as Level 3 and now the underlying securities are Level 2. As noted in the Level 3 rollforward above, the CDSs which are separately recognized as a result of this change in accounting are reported as Level 3 investments. In addition, approximately $1.0 billion of Level 2 investments were reclassified upon the adoption of this guidance, and their underlying securities are being reported as Level 1 as of January 1, 2010.

The significant valuation inputs that are used in the valuation process for the below-investment-grade, callable RDC and private placement investments classified as Level 3 include forward exchange rates, yen swap rates, dollar swap rates, interest rate volatilities, credit spread data on specific issuers, assumed default and default recovery rates, certain probability assumptions, and call option data.

Some of these securities require the calculation of a theoretical forward exchange rate which is developed by using yen swap rates, U.S. dollar swap rates, interest rate volatilities, and spot exchange rates. The forward exchange rate is then used to convert all future dollar cash flows of the bond, where applicable, into yen cash flows. Additionally, credit spreads for the individual issuers are key valuation inputs of these securities. Finally, in pricing securities with a call option, the assumptions regarding interest rates in the U.S. and Japan are considered to be significant valuation inputs. Collectively, these valuation inputs are included to estimate the fair values of these securities at each reporting date.

In obtaining the above valuation inputs, we have determined that certain pricing assumptions and data used by our pricing sources are becoming increasingly more difficult to validate or corroborate by the market and/or appear to be internally developed rather than observed in or corroborated by the market. The use of these unobservable valuation inputs causes more subjectivity in the valuation process for these securities and consequently, causes more volatility in their estimated fair values.

Fair Value of Financial Instruments

The carrying values and estimated fair values of the Company’s financial instruments were as follows:


	June 30, 2011				December 31, 2010
(In millions)	Carrying Value		Fair Value		Carrying Value		Fair Value
Assets:
Fixed-maturity securities	$	78,669	$	78,785	$	72,570	$	72,999
Fixed-maturity securities - consolidated variable interest entities		5,745		5,703		5,869		5,825
Perpetual securities		5,559		5,559		5,974		5,974
Perpetual securities - consolidated variable interest entities		1,544		1,544		1,538		1,538
Equity securities		23		23		23		23
Interest rate, foreign currency, and credit default swaps		495		495		564		564
Liabilities:
Notes payable (excluding capitalized leases)		3,042		3,283		3,032		3,248
Interest rate, foreign currency, and credit default swaps		584		584		741		741
Obligation to Japanese policyholder protection corporation		89		89		108		108

As mentioned previously, we determine the fair values of our debt, perpetual and privately issued equity securities and our derivatives using three basic pricing approaches or techniques: quoted market prices readily available from public exchange markets, pricing models, and price quotes we obtain from outside brokers.

The fair values of notes payable with fixed interest rates were obtained from an independent financial information service. The fair value of the obligation to the Japanese policyholder protection corporation is our estimated share of the industry’s obligation calculated on a pro rata basis by projecting our percentage of the industry’s premiums and reserves and applying that percentage to the total industry obligation payable in future years.

The carrying amounts for cash and cash equivalents, receivables, accrued investment income, accounts payable, cash collateral and payables for security transactions approximated their fair values due to the short-term nature of these instruments. Consequently, such instruments are not included in the above table. The preceding table also excludes liabilities for future policy benefits and unpaid policy claims as these liabilities are not financial instruments as defined by GAAP.

DCF Sensitivity

Our DCF pricing model utilizes various market inputs we obtain from both active and inactive markets. The estimated fair values developed by the DCF pricing models are most sensitive to prevailing credit spreads, the level of interest rates (yields), and, for our callable securities, interest rate volatility. Management believes that under normal market conditions, a movement of 50 basis points (bps) in interest rates and credit spreads and 50 percent in interest rate volatility would be sufficiently reasonable stresses for these risk factors. Therefore, we selected these magnitudes of movements and provided both upward and downward movements in these key assumptions used to estimate fair values. Since the changes in fair value are relatively linear, readers of these financial statements can make their own judgments as to the movement in interest rates and the change in fair value based upon this data. The following scenarios provide a view of the sensitivity of our securities priced by our DCF pricing model.

The fair values of our available-for-sale fixed-maturity and perpetual securities valued by our DCF pricing model totaled $20.3 billion at June 30, 2011. The estimated effect of potential changes in interest rates, credit spreads and interest rate volatility on these fair values as of such date is as follows:


Interest Rates				Credit Spreads				Interest Rate Volatility
Factor change	Change in fair value (in millions)			Factor change	Change in fair value (in millions)			Factor change	Change in fair value (in millions)
+50 bps		$(1,069	)	+50 bps		$(1,054	)	+50 %		$(248	)
-50 bps		1,140		-50 bps		1,122		-50 %		33

The fair values of our held-to-maturity fixed-maturity securities valued by our DCF pricing model totaled $27.2 billion at June 30, 2011. The estimated effect of potential changes in interest rates, credit spreads and interest rate volatility on these fair values as of such date is as follows:


Interest Rates				Credit Spreads				Interest Rate Volatility
Factor change	Change in fair value (in millions)			Factor change	Change in fair value (in millions)			Factor change	Change in fair value (in millions)
+50 bps		$ (1,696	)	+50 bps		$(1,557	)	+50 %		$(385	)
-50 bps		1,747		-50 bps		1,572		-50 %		357

For additional information on our investments and financial instruments, see the accompanying Notes 1, 3 and 4 and Notes 1, 3 and 4 of the Notes to the Consolidated Financial Statements in our annual report to shareholders for the year ended December 31, 2010.