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FAIR VALUE MEASUREMENTS
 12 Months Ended
Dec. 31, 2011
Fair Value Disclosures [Abstract]  
FAIR VALUE MEASUREMENTS [Text Block]

6.       FAIR VALUE MEASUREMENTS

 

Fair Value Hierarchy

 

Fair value is defined as the price to sell an asset or transfer a liability (i.e. the “exit price”) in an orderly transaction between market participants. We use a fair value hierarchy that gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. The hierarchy is broken down into three levels as follows:

 

  • Level 1 - Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access. Valuation adjustments and block discounts are not applied to Level 1 instruments.

     

  • Level 2 - Valuations based on quoted prices in active markets for similar assets or liabilities, quoted prices for identical assets or liabilities in inactive markets, or for which significant inputs are observable (e.g. interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.

  • Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement. The unobservable inputs reflect our own assumptions about assumptions that market participants might use.

 

The availability of observable inputs can vary from financial instrument to financial instrument and is affected by a wide variety of factors including, for example, the type of financial instrument, whether the financial instrument is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires significantly more judgment.

 

Accordingly, the degree of judgment exercised by management in determining fair value is greatest for instruments categorized in Level 3. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This may lead us to change the selection of our valuation technique (from market to income approach) or may cause us to use multiple valuation techniques to estimate the fair value of a financial instrument. This circumstance could cause an instrument to be reclassified between levels.

 

We used the following valuation technique and assumptions in estimating the fair value of our financial instruments as well as the general classification of such financial instruments pursuant to the above fair value hierarchy.

 

Fixed Maturities

 

At each valuation date, we use the market approach valuation technique to estimate the fair value of our fixed maturities portfolio, when possible. This market approach includes, but is not limited to, prices obtained from third party pricing services for identical or comparable securities and the use of “pricing matrix models” using observable market inputs such as yield curves, credit risks and spreads, measures of volatility, and prepayment speeds. Pricing from third party pricing services is sourced from multiple vendors, when available, and we maintain a vendor hierarchy by asset type based on historical pricing experience and vendor expertise. When prices are unavailable from pricing services, we obtain non-binding quotes from broker-dealers who are active in the corresponding markets.

 

The following describes the significant inputs generally used to determine the fair value of our fixed maturities by asset class.

 

U.S. government and agency

U.S. government and agency securities consist primarily of bonds issued by the U.S. Treasury and mortgage pass-through agencies such as the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and the Government National Mortgage Association. As the fair values of our U.S. Treasury securities are based on unadjusted market prices in active markets, they are classified within Level 1. The fair values of U.S. government agency securities are priced using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the fair values of U.S. government agency securities are classified within Level 2.

 

Non-U.S. government

Non-U.S. government securities comprise bonds issued by non-U.S. governments and their agencies along with supranational organizations (also known as sovereign debt securities). The fair value of these securities is based on prices obtained from international indices or a valuation model that includes the following inputs: interest rate yield curves, cross-currency basis index spreads, and country credit spreads for structures similar to the sovereign bond in terms of issuer, maturity and seniority. As the significant inputs are observable market inputs, the fair value of non-U.S. government securities are classified within Level 2.

 

Corporate debt

Corporate debt securities consist primarily of investment-grade debt of a wide variety of corporate issuers and industries. The fair values of these securities are generally determined using the spread above the risk-free yield curve. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As these spreads and the yields for the risk-free yield curve are observable market inputs, the fair values of our corporate debt securities are classified within Level 2. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. In this event, securities are classified within Level 3 and consisted of private corporate debt securities at December 31, 2011.

 

MBS

Our portfolio of RMBS and CMBS are originated by both agencies and non-agencies. The fair values of these securities are determined through the use of a pricing model (including Option Adjusted Spread) which uses prepayment speeds and spreads to determine the appropriate average life of the MBS. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As the significant inputs used to price MBS are observable market inputs, the fair values of the MBS are classified within Level 2. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. These securities are classified within Level 3.

 

ABS

ABS include mostly investment-grade bonds backed by pools of loans with a variety of underlying collateral, including automobile loan receivables, student loans, credit card receivables, and CLO Debt originated by a variety of financial institutions. Similarly to MBS, the fair values of ABS are priced through the use of a model which uses prepayment speeds and spreads sourced primarily from the new issue market. As the significant inputs used to price ABS are observable market inputs, the fair values of ABS are classified within Level 2. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers or use a discounted cash flow model to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly.

 

At December 31, 2011, we continue to use our internal cash flow model (income approach) to estimate the fair value of our investment in CLO Debt given the lack of observable, relevant market trades. During the third quarter of 2011, we modified our valuation model to place more weight on the current implied credit spreads for similar securities rather than the underlying contractual cash flows of the respective CLO Debt. This change did not result in a significant change in the valuation for our CLO Debt for the current year. While the pricing from our valuation model is significantly driven by the current implied yields for similar debt securities, these yields are based on observable offer prices due to the lack of observable market trades, adjusted for an illiquidity premium. Accordingly, we continue to classify these securities within Level 3 in the fair value hierarchy table below.

 

Municipals

Our municipal portfolio comprises bonds issued by U.S. domiciled state and municipality entities. The fair value of these securities is determined using spreads obtained from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the municipals are observable market inputs, municipals are classified within Level 2.

 

Equity Securities

 

Equity securities include U.S. and foreign common stocks, exchange-traded funds, and foreign bond mutual funds. For common stocks and exchange-traded funds, we classified these within Level 1 as their fair values are based on quoted market prices in active markets. Our investments in foreign bond mutual funds have daily liquidity, with redemption based on the net asset value (NAV) of the funds. Accordingly, we have classified these investments as Level 2.

 

Other Investments

 

As a practical expedient, we estimate fair values for hedge and credit funds using NAVs as advised by external fund managers or third party administrators. For our hedge and credit fund investments with liquidity terms allowing us to fully redeem our holdings at the applicable NAV in the near term, we have classified these investments as Level 2. Certain investments in hedge and credit funds have redemption restrictions (see Note 5 for further details) that prevent us from redeeming in the near term and therefore we have classified these investments as Level 3.

 

At December 31, 2011, and 2010, the CLO – Equities were classified within Level 3 as we estimated the fair value for these securities using an income approach valuation technique (internal cash flow model) due to the lack of observable, relevant trades in the secondary markets. The following table presents a range of significant inputs used in our valuation model.

           
 At December 31,    2011 2010 
           
 Default rates4.0% - 5.0% 3.8% - 5.0% 
 Loss severity rate53.5% 65.0% 
 Collateral spreads2.6% - 4.2% 2.4% - 4.2% 
 Estimated maturity dates2.5 - 5.2 years 1.5 - 10.5 years 
           
           
The changes made to the above significant inputs in 2011 did not impact significantly the total change in fair value of the CLO - Equities recognized in earnings.

Derivative Instruments

 

Our foreign currency forward contracts and options are customized to our hedging strategies and trade in the over-the-counter derivative market. We use the market approach valuation technique to estimate the fair value for these derivatives based on significant observable market inputs from third party pricing vendors, non-binding broker-dealer quotes and/or recent trading activity. Accordingly, we classified these derivatives within Level 2.

The table below presents the financial instruments measured at fair value on a recurring basis.
              
  Quoted Prices in  Significant Significant    
  Active Markets for  Other Observable  Unobservable     
  Identical Assets Inputs Inputs Total Fair 
  (Level 1) (Level 2) (Level 3) Value 
 At December 31, 2011            
 Assets            
 Fixed maturities            
  U.S. government and agency $ 765,519 $ 382,748 $ - $ 1,148,267 
  Non-U.S. government   -   1,212,451   -   1,212,451 
  Corporate debt   -   3,608,041   1,550   3,609,591 
  Agency RMBS   -   2,636,634   -   2,636,634 
  CMBS  -   312,691   -   312,691 
  Non-Agency RMBS  -   165,713   -   165,713 
  ABS  -   582,714   49,328   632,042 
  Municipals  -   1,222,711   -   1,222,711 
    765,519   10,123,703   50,878   10,940,100 
 Equity securities  561,436   116,124   -   677,560 
 Other investments   -   286,516   412,804   699,320 
 Other assets (see Note 7)  -   38,175   -   38,175 
  Total $ 1,326,955 $ 10,564,518 $ 463,682 $ 12,355,155 
              
 Liabilities            
 Other liabilities (see Note 7)$ - $2,035 $ - $2,035 
              
              
 At December 31, 2010            
 Assets            
 Fixed maturities            
  U.S. government and agency $ 588,281 $ 271,839 $ - $ 860,120 
  Non-U.S. government   -   772,798   -   772,798 
  Corporate debt   -   4,161,358   1,550   4,162,908 
  Agency RMBS   -   2,593,582   -   2,593,582 
  CMBS  -   474,785   -   474,785 
  Non-Agency RMBS  -   224,524   19,678   244,202 
  ABS  -   618,665   43,178   661,843 
  Municipals  -   712,659   -   712,659 
    588,281   9,830,210   64,406   10,482,897 
 Equity securities  271,451   77,803   -   349,254 
 Other investments   -   -   519,296   519,296 
 Other assets (see Note 7)  -   6,641   -   6,641 
  Total $ 859,732 $ 9,914,654 $ 583,702 $ 11,358,088 
              
 Liabilities            
 Other liabilities (see Note 7)$ - $ 14,986 $ - $ 14,986 
            
              
During 2011 and 2010, we had no transfers between Levels 1 and 2.

Level 3 financial instruments                     
                       
The following tables present changes in Level 3 for financial instruments measured at fair value on a recurring basis for the periods indicated: 
                       
   Fixed Maturities       
   Corporate      Non-Agency        Other  Total 
   Debt  CMBS  RMBS   ABS  Total  Investments  Assets 
                       
 Year ended December 31, 2011                     
 Balance at beginning of period$ 1,550 $ - $ 19,678 $ 43,178 $ 64,406 $ 519,296 $ 583,702 
 Total net realized and unrealized gains                     
  included in net income(1)  -   -   -   -   -   74,497   74,497 
 Total net realized and unrealized losses                      
  included in net income(1)  -   -   -   -   -   (43,498)   (43,498) 
 Change in net unrealized gains included                      
  in other comprehensive income  -   -   123   5,289   5,412   -   5,412 
 Change in net unrealized losses included                     
  in other comprehensive income  -   -   (60)   (937)   (997)   -   (997) 
 Purchases   -   -   -   -   -   195,000   195,000 
 Sales  -   -   -   -   -   (25,268)   (25,268) 
 Settlements / distributions  -   -   (2,046)   (93)   (2,139)   (45,720)   (47,859) 
 Transfers into Level 3  -   -   -   1,891   1,891   -   1,891 
 Transfers out of Level 3  -   -   (17,695)   -   (17,695)   (261,503)   (279,198) 
 Balance at end of period$ 1,550 $ - $ - $ 49,328 $ 50,878 $ 412,804 $ 463,682 
                       
 Level 3 gains / losses included in                     
  earnings attributable to the change                     
  in unrealized gains /losses relating                     
  to those assets held at the                     
  reporting date$ - $ - $ - $ - $ - $ 31,855 $ 31,855 
                       
 Year ended December 31, 2010                     
 Balance at beginning of period$ 18,130 $ 2,409 $ 6,639 $ 43,585 $ 70,763 $ 520,188 $ 590,951 
 Total net realized and unrealized gains                     
  included in net income(1)  -   -   -   -   -   60,969   60,969 
 Total net realized and unrealized losses                      
  included in net income(1)  (1,550)   (119)   (581)   (1,134)   (3,384)   -   (3,384) 
 Change in net unrealized gains included                      
  in other comprehensive income  2,201   1,273   1,825   3,361   8,660   -   8,660 
 Change in net unrealized losses included                     
  in other comprehensive income  (34)   (238)   (27)   (71)   (370)   -   (370) 
 Purchases   -   3,474   20,230   4,000   27,704   65,000   92,704 
 Sales  (12)   (206)   (211)   (2,004)   (2,433)   (99,822)   (102,255) 
 Settlements / distributions  -   (694)   (1,832)   (369)   (2,895)   (27,039)   (29,934) 
 Transfers into Level 3  -   -   781   -   781   -   781 
 Transfers out of Level 3  (17,185)   (5,899)   (7,146)   (4,190)   (34,420)   -   (34,420) 
 Balance at end of period$ 1,550 $ - $ 19,678 $ 43,178 $ 64,406 $ 519,296 $ 583,702 
                       
 Level 3 gains / losses included in                     
  earnings attributable to the change                     
  in unrealized gains /losses relating                     
  to those assets held at the                     
  reporting date$ (1,550) $ - $ - $ - $ (1,550) $ 60,969 $ 59,419 
                       
(1) Realized gains and losses on fixed maturities are included in net realized investment gains (losses). Realized gains and (losses) on other investments are included in net investment income.

The transfers into and out of fair value hierarchy levels reflect the fair value of the securities at the end of the reporting period.

 

Transfers into Level 3 from Level 2

The transfers to Level 3 from Level 2 made in 2010 and 2011 were due to a reduction in the volume of recently executed transactions or a lack of available quotes from pricing vendors and broker-dealers. None of the transfers were as a result of changes in valuation methodology that we made.

 

Transfers out of Level 3 into Level 2

During 2011, the transfer of fixed maturities from Level 3 to Level 2 relates to non-agency RMBS for which observable market inputs and multiple quotes from pricing vendors and broker-dealers became available during the year as a result of the return of liquidity in this asset class. We also transferred certain hedge and credit funds (included in “other investments”) from Level 3 to Level 2 during 2011 as we have the ability to liquidate these holdings at the reported NAV in the near term.

 

During 2010, the transfer relating to corporate debt was in relation to one issuer as a result of entering into an agreement to take delivery of a new corporate debt security, which its fair value measurement was based on observable market inputs. The remaining transfers out of Level 3 into Level 2 made in 2010 were primarily due to the availability of observable market inputs and multiple quotes from pricing vendors and broker-dealers as a result of the return of liquidity in the credit markets.

 

Fair Values of Financial Instruments

 

The carrying amount of financial assets and liabilities presented on the Consolidated Balance Sheets as at December 31, 2011, and December 31, 2010 approximated their fair values with the exception of senior notes. At December 31, 2011, the senior notes are recorded at amortized cost with a carrying value of $995 million (2010: $994 million) and a fair value of $1,039 million (2010: $1,018 million).