3 Fair value disclosures

Fair value, as defined by the Fair Value Measurements and Disclosures Topic, is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

The Fair Value Measurements and Disclosures Topic requires all assets and liabilities that are measured at fair value to be categorised within the fair value hierarchy. This three-level hierarchy is based on the observability of the inputs used in the fair value measurement. The levels of the fair value hierarchy are defined as follows:

Level 1 inputs are quoted prices in active markets for identical assets or liabilities that the Group has the ability to access. Level 1 inputs are the most persuasive evidence of fair value and are to be used whenever possible.

Level 2 inputs are market-based inputs that are directly or indirectly observable, but not considered level 1 quoted prices. Level 2 inputs consist of (i) quoted prices for similar assets or liabilities in active markets; (ii) quoted prices for identical assets or liabilities in non-active markets (eg markets which have few transactions and where prices are not current or price quotations vary substantially); (iii) inputs other than quoted prices that are observable (eg interest rates, yield curves, volatilities, prepayment speeds, credit risks and default rates); and (iv) inputs derived from, or corroborated by, observable market data.

Level 3 inputs are unobservable inputs. These inputs reflect the Group’s own assumptions about market pricing using the best internal and external information available.

The types of instruments valued, based on unadjusted quoted market prices in active markets, include most US government and sovereign obligations, active listed equities and most money market securities. Such instruments are generally classified within level 1 of the fair value hierarchy.

The types of instruments that trade in markets that are not considered to be active, but are valued based on quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency, include most government agency securities, investment-grade corporate bonds, certain mortgage- and asset-backed products, less liquid listed equities, and state, municipal and provincial obligations. Such instruments are generally classified within level 2 of the fair value hierarchy.

Exchange-traded derivative instruments typically fall within level 1 or level 2 of the fair value hierarchy depending on whether they are considered to be actively traded or not.

Certain financial instruments are classified within level 3 of the fair value hierarchy, because they trade infrequently and therefore have little or no price transparency. Such instruments include private equity, less liquid corporate debt securities and certain asset-backed securities. Certain over-the-counter derivatives trade in less liquid markets with limited pricing information, and the determination of fair value for these derivatives is inherently more difficult. Such instruments are classified within level 3 of the fair value hierarchy. Pursuant to the election of the fair value option, the Group classifies certain liabilities for life and health policy benefits in level 3 of the fair value hierarchy. When appropriate, valuations are adjusted for various factors such as liquidity, bid/offer spreads, and credit considerations. Such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used.

The fair values of assets are adjusted to incorporate the counterparty risk of non-performance. Similarly, the fair values of liabilities reflect the risk of non-performance of the Group, captured by the Group’s credit spread. These valuation adjustments from assets and liabilities measured at fair value using significant unobservable inputs are recognised in net realised gains and losses. For the year ended 31 December 2013, these adjustments were not material. Whenever the underlying assets or liabilities are reported in a specific business segment, the valuation adjustment is allocated accordingly. Valuation adjustments not attributable to any business segment are reported in Group items.

In certain situations, the Group uses inputs to measure the fair value of asset or liability positions that fall into different levels of the fair value hierarchy. In these situations, the Group will determine the appropriate level based on the lowest level input that is significant to the determination of the fair value.

Valuation techniques

US government securities typically have quoted market prices in active markets and are categorised as level 1 instruments in the fair value hierarchy. Non-US government holdings are generally classified as level 2 instruments and are valued on the basis of the quotes provided by pricing services, which are subject to the Group’s pricing validation reviews and pricing vendor challenge process. Valuations provided by pricing vendors are generally based on the actual trade information as substantially all of the Group’s non-US government holdings are traded in a transparent and liquid market.

Corporate debt securities mainly include US and European investment-grade positions, which are priced on the basis of quotes provided by third-party pricing vendors and first utilise valuation inputs from actively traded securities, such as bid prices, bid spreads to Treasury securities, Treasury curves, and same or comparable issuer curves and spreads. Issuer spreads are determined from actual quotes and traded prices and incorporate considerations of credit/default, sector composition, and liquidity and call features. Where market data is not available, valuations are developed based on the modelling techniques that utilise observable inputs and option-adjusted spreads and incorporate considerations of the security’s seniority, maturity and the issuer’s corporate structure.

Values of residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS) and other asset-backed securities (Other ABS) are obtained both from third-party pricing vendors and through quoted prices, some of which may be based on the prices of comparable securities with similar structural and collateral features. Values of certain ABS for which there are no significant observable inputs are developed using benchmarks to similar transactions or indices. For both RMBS and CMBS, cash flows are derived based on the transaction-specific information, which incorporates priority in the capital structure, and are generally adjusted to reflect benchmark yields, market prepayment data, collateral performance (default rates and loss severity) for specific vintage and geography, credit enhancements, and ratings. For certain RMBS and CMBS with low levels of market liquidity, judgments may be required to determine comparable securities based on the loan type and deal-specific performance. CMBS terms may also incorporate lock-out periods that restrict borrowers from prepaying the loans or provide disincentives to prepay and therefore reduce prepayment risk of these securities, compared to RMBS. The factors specifically considered in valuation of CMBS include borrower-specific statistics in a specific region, such as debt service coverage and loan-to-value ratios, as well as the type of commercial property.

The category “Other ABS” primarily includes debt securitised by credit card, student loan and auto loan receivables. Pricing inputs for these securities also focus on capturing, where relevant, collateral quality and performance, payment patterns, and delinquencies.

The Group uses third-party pricing vendor data to value agency securitised products, which mainly include collateralised mortgage obligations (CMO) and mortgage-backed government agency securities. The valuations generally utilise observable inputs consistent with those noted above for RMBS and CMBS.

Equity securities held by the Group for proprietary investment purposes are mainly classified in levels 1 and 2. Securities classified in level 1 are traded on public stock exchanges for which quoted prices are readily available. Level 2 equities include equity investments fair valued pursuant to the fair value option election and certain hedge fund positions; all valued based on primarily observable inputs.

The category “Other invested assets” mainly includes the Group’s private equity and hedge fund investments which are made directly or via ownership of funds. Substantially all these investments are classified as level 3 due to the lack of observable prices and significant judgment required in valuation. Valuation of direct private equity investments requires significant management judgment due to the absence of quoted market prices and the lack of liquidity. Initial valuation is based on the acquisition cost, and is further refined based on the available market information for the public companies that are considered comparable to the Group’s holdings in the private companies being valued, and the private company-specific performance indicators; both historic and projected. Subsequent valuations also reflect business or asset appraisals, as well as market transaction data for private and public benchmark companies and the actual companies being valued, such as financing rounds and mergers and acquisitions activity. The Group’s holdings in the private equity and hedge funds are generally valued utilising net asset values (NAV), subject to adjustments, as deemed necessary, for restrictions on redemption (lock-up periods and amount limitations on redemptions).

The Group holds both exchange-traded and over-the-counter (OTC) interest rate, foreign exchange, credit and equity derivative contracts for hedging and trading purposes. The fair values of exchange-traded derivatives measured using observable exchange prices are classified in level 1. Long-dated contracts may require adjustments to the exchange-traded prices which would trigger reclassification to level 2 in the fair value hierarchy. OTC derivatives are generally valued by the Group based on the internal models, which are consistent with industry standards and practices, and use both observable (dealer, broker or market consensus prices, spot and forward rates, interest rate and credit curves and volatility indices) and unobservable inputs (adjustments for liquidity, inputs derived from the observable data based on the Group’s judgments and assumptions).

The Group’s OTC interest rate derivatives primarily include interest rate swaps, futures, options, caps and floors, and are valued based on the cash flow discounting models which generally utilise as inputs observable market yield curves and volatility assumptions.

The Group’s OTC foreign exchange derivatives primarily include forward, spot and option contracts and are generally valued based on the cash flow discounting models, utilising as main inputs observable foreign exchange forward curves.

The Group’s investments in equity derivatives primarily include OTC equity option contracts on single or baskets of market indices and equity options on individual or baskets of equity securities, which are valued using internally developed models (such as the Black-Scholes option pricing model and various simulation models) calibrated with the inputs, which include underlying spot prices, dividend curves, volatility surfaces, yield curves, and correlations between underlying assets.

The Group’s OTC credit derivatives include index and single-name credit default swaps, as well as more complex structured credit derivatives. Plain vanilla credit derivatives, such as index and single-name credit default swaps, are valued by the Group based on the models consistent with the industry valuation standards for these credit contracts, and primarily utilising observable inputs published by market data sources, such as credit spreads and recovery rates. These valuation techniques warrant classification of plain vanilla OTC derivatives as level 2 financial instruments in the fair value hierarchy.

The Group also holds complex structured credit contracts, such as credit default swaps (CDS) referencing mortgage-backed securities, certain types of collateralised debt obligation (CDO) transactions, and the products sensitive to correlation between two or more underlying parameters (CDO-squared); all of which are classified within level 3 of the fair value hierarchy. A CDO is a debt instrument collateralised by various debt obligations, including bonds, loans and CDS of differing credit profiles. In a CDO-squared transaction, both the primary instrument and the underlying instruments are represented by CDOs. Generally, for CDO and CDO-squared transactions, the observable inputs such as CDS spreads and recovery rates are modified to adjust for correlation between the underlying debt instruments. The correlation levels are modelled at the portfolio level and calibrated at a transaction level to liquid benchmark rates.

Governance around level 3 fair valuation

The Group Risk & Capital Committee, chaired by the Group Chief Risk Officer, has a primary responsibility for governing and overseeing all of the Group’s valuation policies and operating parameters (including level 3 measurements). The Group Risk & Capital Committee delegates the responsibility for implementation and oversight of consistent application of the Group’s pricing and valuation policies to the Pricing and Valuation Committee, which is a management control committee. Key functions of the Pricing and Valuation Committee include: oversight over the entire valuation process, approval of internal valuation methodologies, approval of external pricing vendors, monitoring of the independent price verification (IPV) process and resolution of significant or complex valuation issues.

A formal IPV process is undertaken monthly by members of the IPV team within a Financial Risk Management function. The process includes monitoring and in-depth analyses of approved pricing methodologies and valuations of the Group’s financial instruments aimed at identifying and resolving pricing discrepancies.

The Risk function is responsible for independent validation and ongoing review of the Group’s valuation models. The Product Control group within Finance is tasked with reporting of fair values and is empowered to challenge vendor- and model-based valuations.

Assets and liabilities measured at fair value on a recurring basis

As of 31 December, the fair values of assets and liabilities measured on a recurring basis by level of input were as follows:

Download

2012
USD millions

Quoted prices in active markets for identical assets and liabilities (Level 1)

Significant other observable inputs (Level 2)

Significant unobservable inputs (Level 3)

Impact of netting1

Total

1

The netting of derivative receivables and derivative payables is permitted when a legally enforceable master netting agreement exists between two counterparties. A master netting agreement provides for the net settlement of all contracts, as well as cash collateral, through a single payment, in a single currency, in the event of default or on the termination of any one contract.

Assets

 

 

 

 

 

Fixed income securities held for proprietary investment purposes

13 474

74 676

698

 

88 848

Debt securities issued by US government and government agencies

13 474

752

 

 

14 226

US Agency securitised products

 

4 178

 

 

4 178

Debt securities issued by non-US governments and government agencies

 

39 608

 

 

39 608

Corporate debt securities

 

23 149

685

 

23 834

Residential mortgage-backed securities

 

990

 

 

990

Commercial mortgage-backed securities

 

3 199

13

 

3 212

Other asset-backed securities

 

2 800

 

 

2 800

Fixed income securities backing unit-linked and with-profit life and health policies

 

4 630

 

 

4 630

Equity securities

21 781

536

74

 

22 391

Equity securities backing unit-linked and with-profit life and health policies

18 607

10

 

 

18 617

Equity securities held for proprietary investment purposes

3 174

526

74

 

3 774

Derivative financial instruments

262

6 657

1 010

–5 645

2 284

Interest rate contracts

194

5 235

 

 

5 429

Foreign exchange contracts

26

415

 

 

441

Derivative equity contracts

34

508

636

 

1 178

Credit contracts

 

392

223

 

615

Other contracts

8

107

151

 

266

Other invested assets

747

1 372

2 098

 

4 217

Total assets at fair value

36 264

87 871

3 880

–5 645

122 370

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Derivative financial instruments

–274

–5 574

–2 865

4 990

–3 723

Interest rate contracts

–205

–3 972

 

 

–4 177

Foreign exchange contracts

–12

–792

 

 

–804

Derivative equity contracts

–43

–380

–232

 

–655

Credit contracts

 

–412

–271

 

–683

Other contracts

–14

–18

–2 362

 

–2 394

Liabilities for life and health policy benefits

 

 

–272

 

–272

Accrued expenses and other liabilities

–885

–2 556

 

 

–3 441

Total liabilities at fair value

–1 159

–8 130

–3 137

4 990

–7 436

 

 

 

 

 

 

 

 

 

 

 

 

2013
USD millions

Quoted prices in active markets for identical assets and liabilities (Level 1)

Significant other observable inputs (Level 2)

Significant unobservable inputs (Level 3)

Impact of netting1

Total

Assets

 

 

 

 

 

Fixed income securities held for proprietary investment purposes

5 454

73 180

662

 

79 296

Debt securities issued by US government and government agencies

5 454

1 537

 

 

6 991

US Agency securitised products

 

3 946

 

 

3 946

Debt securities issued by non-US governments and government agencies

 

30 092

 

 

30 092

Corporate debt securities

 

30 904

650

 

31 554

Residential mortgage-backed securities

 

915

 

 

915

Commercial mortgage-backed securities

 

2 935

12

 

2 947

Other asset-backed securities

 

2 851

 

 

2 851

Fixed income securities backing unit-linked and with-profit life and health policies

 

4 585

 

 

4 585

Equity securities

28 257

565

49

 

28 871

Equity securities backing unit-linked and with-profit life and health policies

21 169

11

 

 

21 180

Equity securities held for proprietary investment purposes

7 088

554

49

 

7 691

Derivative financial instruments

31

3 563

505

–2 877

1 222

Interest rate contracts

8

2 372

 

 

2 380

Foreign exchange contracts

 

267

 

 

267

Derivative equity contracts

23

842

401

 

1 266

Credit contracts

 

18

28

 

46

Other contracts

 

64

76

 

140

Other invested assets

1 476

210

2 256

 

3 942

Total assets at fair value

35 218

82 103

3 472

–2 877

117 916

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Derivative financial instruments

–14

–3 097

–993

2 656

–1 448

Interest rate contracts

 

–2 123

 

 

–2 123

Foreign exchange contracts

 

–428

 

 

–428

Derivative equity contracts

–14

–527

–190

 

–731

Credit contracts

 

–11

–38

 

–49

Other contracts

 

–8

–765

 

–773

Liabilities for life and health policy benefits

 

 

–145

 

–145

Accrued expenses and other liabilities

–1 634

–1 271

 

 

–2 905

Total liabilities at fair value

–1 648

–4 368

–1 138

2 656

–4 498

Assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (level 3)

As of 31 December, the reconciliation of the fair values of assets and liabilities measured on a recurring basis using significant unobservable inputs were as follows:

Enlarge table Download

2012
USD millions

Corporate debt securities

Residential mortgage-backed securities

Commercial mortgage-backed securities

Other asset-backed securities

Equity securities held for proprietary investment purposes

Derivative interest rate contracts

Derivative foreign exchange contracts

Derivative equity contracts

Derivative credit contracts

Other derivative contracts

Other invested assets

    Total

1

Transfers are recognised at the date of the event or change in circumstances that caused the transfer. With the introduction of ASU No. 2011-4 the Group has reassessed the observability of fair value inputs as of 1 January 2012. Yield curves for instruments with maturities above 20 years were deemed observable and related positions were therefore reclassified to level 2. The inputs of one level 2 position were assessed to be unobservable, the respective assets and liabilities were therefore shifted to level 3.

Assets

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of 1 January 2012

1 111

4

8

16

69

1 471

112

41

986

36

2 041

5 895

Realised/unrealised gains/losses:

 

 

 

 

 

 

 

 

 

 

 

 

Included in net income

49

 

–1

 

20

7

 

–192

–430

44

–15

–518

Included in other comprehensive income

–18

 

2

 

3

 

 

 

 

 

121

108

Purchases

51

 

6

32

 

 

 

 

 

43

192

324

Issuances

 

 

 

 

 

 

 

 

 

 

 

0

Sales

–448

 

–40

–32

–18

 

 

 

–33

 

–216

–787

Settlements

–58

 

 

–9

 

–7

 

 

–81

–12

–2

–169

Transfers into level 31

24

 

41

 

 

3

 

828

38

40

41

1 015

Transfers out of level 31

–26

–4

–3

–7

 

–1 474

–112

–41

–257

 

–74

–1 998

Impact of foreign exchange movements

 

 

 

 

 

 

 

 

 

 

10

10

Closing balance as of 31 December 2012

685

0

13

0

74

0

0

636

223

151

2 098

3 880

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative interest rate contracts

Derivative foreign exchange contracts

Derivative equity contracts

Derivative credit contracts

Other derivative contracts

Liabilities for life and health policy benefits

Total

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of 1 January 2012

 

 

 

 

 

–1 075

–66

–170

–1 075

–3 489

–341

–6 216

Realised/unrealised gains/losses:

 

 

 

 

 

 

 

 

 

 

 

 

Included in net income

 

 

 

 

 

 

 

59

582

1 043

68

1 752

Included in other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

0

Purchases

 

 

 

 

 

 

 

 

 

 

 

0

Issuances

 

 

 

 

 

–2

 

–19

 

–50

 

–71

Sales

 

 

 

 

 

2

 

96

 

 

 

98

Settlements

 

 

 

 

 

 

 

54

7

–26

 

35

Transfers into level 31

 

 

 

 

 

 

 

–368

–126

–29

 

–523

Transfers out of level 31

 

 

 

 

 

1 075

66

116

341

189

 

1 787

Impact of foreign exchange movements

 

 

 

 

 

 

 

 

 

 

1

1

Closing balance as of 31 December 2012

 

 

 

 

 

0

0

–232

–271

–2 362

–272

–3 137

Enlarge table Download

2013
USD millions

Corporate debt securities

Commercial mortgage-backed securities

Other asset-backed securities

Equity securities held for proprietary investment purposes

Derivative equity contracts

Derivative credit contracts

Other derivative contracts

Other invested assets

Total

Assets

 

 

 

 

 

 

 

 

 

Balance as of 1 January 2013

685

13

0

74

636

223

151

2 098

3 880

Realised/unrealised gains/losses:

 

 

 

 

 

 

 

 

 

Included in net income

–4

 

 

4

–235

44

–139

108

–222

Included in other comprehensive income

 

 

 

1

 

 

 

12

13

Purchases

37

 

16

 

 

13

12

346

424

Issuances

 

 

 

 

 

 

100

 

100

Sales

–23

 

–16

–30

 

–182

–51

–462

–764

Settlements

–45

–1

 

 

 

–70

3

 

–113

Transfers into level 3

 

 

 

 

 

 

 

419

419

Transfers out of level 3

 

 

 

 

 

 

 

–292

–292

Impact of foreign exchange movements

 

 

 

 

 

 

 

27

27

Closing balance as of 31 December 2013

650

12

0

49

401

28

76

2 256

3 472

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative equity contracts

Derivative credit contracts

Other derivative contracts

Liabilities for life and health policy benefits

Total

Liabilities

 

 

 

 

 

 

 

 

 

Balance as of 1 January 2013

 

 

 

 

–232

–271

–2 362

–272

–3 137

Realised/unrealised gains/losses:

 

 

 

 

 

 

 

 

 

Included in net income

 

 

 

 

53

–14

1 685

131

1 855

Included in other comprehensive income

 

 

 

 

 

 

 

 

0

Purchases

 

 

 

 

 

 

 

 

0

Issuances

 

 

 

 

 

 

–62

 

–62

Sales

 

 

 

 

 

160

50

 

210

Settlements

 

 

 

 

–11

87

–76

 

0

Transfers into level 3

 

 

 

 

 

 

 

 

0

Transfers out of level 3

 

 

 

 

 

 

 

 

0

Impact of foreign exchange movements

 

 

 

 

 

 

 

–4

–4

Closing balance as of 31 December 2013

 

 

 

 

–190

–38

–765

–145

–1 138

Gains and losses on assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (level 3)

The gains and losses relating to the assets and liabilities measured at fair value using significant unobservable inputs (level 3) for the years ended 31 December were as follows:

Download

USD millions

2012

2013

Gains/losses included in net income for the period

1 234

1 633

Whereof change in unrealised gains/losses relating to assets and liabilities still held at the reporting date

1 005

1 484

Assets and liabilities measured at fair value on a non-recurring basis

The acquired present value of future profits (PVFP) of business in force is recorded in connection with the acquisition of life and/or health business. The initial value is determined actuarially by discounting estimated future gross profits as a measure of the value of business acquired. The resulting asset is amortised on a constant yield basis over the expected revenue recognition period of the business acquired, generally over periods ranging up to 30 years, with the accrual of interest added to the unamortised balance at the earned rate. The carrying value of PVFP is reviewed periodically for indicators of impairment in value. Adjustments to reflect impairment in value are recognised in earnings during the period in which the determination of impairment is made.

Transfers between level 1 and level 2

Transfers between level 1 and level 2 for the year ended 31 December 2012 were as follows:

Download

2012
USD millions

Quoted prices in active markets for identical assets and liabilities (Level 1)

Significant other observable inputs (Level 2)

1

Transfers are recognised at the date of the event or change in circumstances that caused the transfer. With the introduction of ASU No. 2011-4, the Group has reassessed the observability of fair value inputs as of 1 January 2012. Yield curves for instruments with maturities above 20 years were deemed observable and related positions were therefore reclassified from level 3 to level 2. The inputs of one level 2 position were assessed to be unobservable, the respective assets and liabilities were therefore shifted to level 3.

Assets

 

 

Transfer into1

191

2 358

Transfer out of1

–78

–1 388

 

 

 

Liabilities

 

 

Transfer into1

 

–1 930

Transfer out of1

 

589

There were no material transfers between level 1 and level 2 for the year ended 31 December 2013.

Quantitative information about level 3 fair value measurements

Unobservable inputs for major level 3 assets and liabilities as of 31 December were as follows:

Enlarge table Download

USD millions

2012
Fair value

2013
Fair value

Valuation technique

Unobservable input

Range (weighted average)

1

Represents average input value for the reporting period.

Assets

 

 

 

 

 

Corporate debt securities

685

650

 

 

 

Surplus notes with a mortality underlying

168

195

Discounted cash flow model

Illiquidity premium

75 bps (n.a.)

Private placement corporate debt

437

383

Corporate spread matrix

Illiquidity premium

0 bps–250 bps (79 bps)

Private placement credit tenant leases

72

68

Discounted cash flow model

Illiquidity premium

75 bps–200 bps (129 bps)

 

 

 

 

 

 

Derivative equity contracts

636

401

 

 

 

OTC equity option referencing correlated equity indices

636

401

Proprietary option model

Correlation

–10%–100% (45%)1

 

 

 

 

 

 

Derivative credit contracts

223

28

 

 

 

Credit default swaps referencing various asset-backed securities (ABS)

109

22

Credit spreads derived based on a reciprocal of a reference instrument

Up-front credit default swap premium

5%–94% (81%)

Credit correlation tranche transactions

112

6

Base correlation model

Correlation

40%–88% (64%)1

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Derivative equity contracts

–232

–190

 

 

 

OTC equity option referencing correlated equity indices

–81

–49

Proprietary option model

Correlation

–10%–100% (45%)1

Option contract referencing a private equity underlying

–144

–137

Option model

Volatility

100%

 

 

 

 

Growth rate

6% (n.a.)

 

 

 

 

 

 

Derivative credit contracts

–271

–38

 

 

 

Credit default swaps referencing various asset-backed securities (ABS)

–86

–7

Credit spreads derived based on a reciprocal of a reference instrument

Up-front credit default swap premium

1%–91% (65%)

Credit correlation tranche transactions

–171

–30

Base correlation model

Correlation

40%–88% (64%)1

 

 

 

 

 

 

Other derivative contracts and liabilities for life and health policy benefits

–2 634

–910

 

 

 

Variable annuity and fair valued GMDB contracts

–2 287

–677

Discounted cash flow model

Risk margin

4% (n.a.)

 

 

 

 

Volatility

4%–42%

 

 

 

 

Lapse

0.5%–24%

 

 

 

 

Mortality adjustment

–10%–0%

 

 

 

 

Withdrawal rate

0%–90%

Embedded derivatives in Mod-Co and Coinsurance with Funds Withheld treaties

–170

–125

Discounted cash flow model

Lapse

3%–10%

 

 

 

 

Mortality adjustment

80% (n.a.)

Sensitivity of recurring level 3 measurements to changes in unobservable inputs

The significant unobservable input used in the fair value measurement of the Group’s surplus notes, private placement debt securities and private placement credit tenant leases is illiquidity premium. A significant increase (decrease) in this input in isolation would result in a significantly higher (lower) fair value measurement.

The significant unobservable input used in the fair value measurement of the Group’s OTC equity option referencing correlated equity indices is correlation. Where the Group is long correlation risk, a significant increase (decrease) in this input in isolation would result in a significantly higher (lower) fair value measurement. Where the Group is short correlation risk, a significant increase (decrease) in this input in isolation would result in a significantly lower (higher) fair value measurement.

The significant unobservable input used in the fair value measurement of the Group’s credit default swaps referencing ABS is a current up-front credit default swap premium. Where the Group is long protection, a significant increase (decrease) in this input in isolation would result in a significantly higher (lower) fair value measurement. Where the Group is short protection, a significant decrease (increase) in this input in isolation would result in a significantly higher (lower) fair value measurement.

The significant unobservable input used in the fair value measurement of the Group’s credit correlation tranche transactions is correlation. Where the Group is long correlation, a significant increase (decrease) in this input in isolation would result in a significantly higher (lower) fair value measurement. Where the Group is short correlation, a significant increase (decrease) in this input in isolation would result in a significantly lower (higher) fair value measurement.

The significant unobservable inputs used in the fair value measurement of the Group’s option referencing private equity underlying are: volatility and growth rate. Where the Group is long vega, a significant increase (decrease) in volatility in isolation would result in a significantly higher (lower) fair value measurement. Where the Group is short vega, a significant increase (decrease) in volatility in isolation would result in a significantly lower (higher) fair value measurement. Where the Group is long delta, a significant increase (decrease) in the growth rate in isolation would result in a significantly higher (lower) fair value measurement. Where the Group is short delta, a significant increase (decrease) in the growth rate in isolation would result in a significantly lower (higher) fair value measurement.

The significant unobservable inputs used in the fair value measurement of the Group’s variable annuity and fair valued guaranteed minimum death benefit (GMDB) contracts are: risk margin, volatility, lapse, mortality adjustment rate and withdrawal rate. A significant increase (decrease) in isolation in each of the following inputs: risk margin, volatility and withdrawal rate would result in a significantly higher (lower) fair value of the Group’s obligation. A significant increase (decrease) in isolation in a lapse rate for in-the-money contracts would result in a significantly lower (higher) fair value of the Group’s obligation, whereas for out-of-the-money contracts, an isolated increase (decrease) in a lapse assumption would increase (decrease) fair value of the Group’s obligation. Changes in the mortality adjustment rate impact fair value of the Group’s obligation differently for living-benefit products, compared to death-benefit products. For the former, a significant increase (decrease) in the mortality adjustment rate (i.e. increase (decrease) in mortality, respectively) in isolation would result in a decrease (increase) in fair value of the Group’s liability. For the latter, a significant increase (decrease) in the mortality adjustment rate in isolation would result in an increase (decrease) in fair value of the Group’s liability.

The significant unobservable inputs underlying the fair valuation of an embedded derivative bifurcated from the Group’s modified coinsurance (Mod-Co) and Coinsurance with Funds Withheld treaties are lapse and mortality adjustment to published mortality tables; both are applied to build an expectation of cash flows associated with the underlying block of term business. Both inputs are not expected to significantly fluctuate over time.

Other invested assets measured at net asset value

Other invested assets measured at net asset value as of 31 December, respectively, were as follows:

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USD millions

2012 Fair value

2013 Fair value

Unfunded commitments

Redemption frequency
(if currently eligible)

Redemption notice period

1

The redemption frequency varies from monthly to up to three years.

2

Cash distribution can be delayed for up to three years depending on the sale of the underlyings.

Private equity funds

701

735

301

non-redeemable

n.a.

Hedge funds

1 140

749

 

redeemable1

90–180 days2

Private equity direct

96

138

 

non-redeemable

n.a.

Real estate funds

223

231

97

non-redeemable

n.a.

Total

2 160

1 853

398

 

 

The hedge fund investments employ a variety of strategies, including global macro, relative value and event-driven strategies, across various asset classes, including long/short equity and credit investments.

The private equity direct portfolio consists of equity and equity-like investments directly in other companies. These investments have no contractual term and are generally held based on financial or strategic intent.

Private equity and real estate funds generally have limitations imposed on the amount of redemptions from the fund during the redemption period due to illiquidity of the underlying investments. Fees may apply for redemptions or transferring of interest to other parties. Distributions are expected to be received from these funds as the underlying assets are liquidated over the life of the fund, which is generally from 10 to 12 years.

The redemption frequency of hedge funds varies depending on the manager as well as the nature of the underlying product. Additionally, certain funds may impose lock-up periods and redemption gates as defined in the terms of the individual investment agreement.

Fair value option

The fair value option under the Financial Instruments Topic permits the choice to measure specified financial assets and liabilities at fair value on an instrument-by-instrument basis.

The Group elected the fair value option for positions in the following line items in the balance sheet:

Equity securities trading

The Group elected the fair value option for an investment previously classified as available-for-sale within other invested assets in the balance sheet. The Group economically hedges the investment with derivative instruments that offset this exposure. The changes in fair value of the derivatives are recorded in earnings. Electing the fair value option eliminates the mismatch previously caused by the economic hedging of the investment and reduces the volatility in the income statement.

Other invested assets

The Group elected the fair value option for certain investments classified as equity method investees within other invested assets in the balance sheet. The Group applied the fair value option, as the investments are managed on a fair value basis. The changes in fair value of these elected investments are recorded in earnings.

Liabilities for life and health policy benefits

The Group elected the fair value option for existing GMDB reserves related to certain variable annuity contracts which are classified as universal life-type contracts. The Group has applied the fair value option, as the equity risk associated with those contracts is managed on a fair value basis and it is economically hedged with derivative options in the market.

Assets and liabilities measured at fair value pursuant to election of the fair value option

Pursuant to the election of the fair value option for the items described, the balances as of 31 December were as follows:

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USD millions

2012

2013

Assets

 

 

Equity securities held for proprietary investment purposes

672

615

of which at fair value pursuant to the fair value option

509

544

Other invested assets

 

11 164

of which at fair value pursuant to the fair value option

 

403

Liabilities

 

 

Liabilities for life and health policy benefits

–36 117

–36 033

of which at fair value pursuant to the fair value option

–272

–145

Changes in fair values for items measured at fair value pursuant to election of the fair value option

Gains/losses included in earnings for the years ended 31 December for items measured at fair value pursuant to election of the fair value option including foreign exchange were as follows:

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USD millions

2012

2013

Equity securities held for proprietary investment purposes

54

35

Other invested assets

 

72

Liabilities for life and health policy benefits

71

125

Total

125

232

Fair value changes from equity securities trading are reported in “Net realised investment gains/losses – non-participating business”. Fair value changes from other invested assets are reported in “Net investment income – non-participating”. Fair value changes from the GMDB reserves are shown in “Life and health benefits”.

Assets and liabilities not measured at fair value but for which the fair value is disclosed

Assets and liabilities not measured at fair value but for which the fair value is disclosed as of 31 December, were as follows:

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2012
USD millions

Significant other observable inputs (Level 2)

Significant unobservable inputs (Level 3)

Total

 

 

 

 

 

 

 

 

2013
USD millions

Significant other observable inputs (Level 2)

Significant unobservable inputs (Level 3)

Total

Assets

 

 

 

Policy loans

 

270

270

Mortgage loans

 

1 801

1 801

Other loans

 

824

824

Investment real estate

 

2 551

2 551

Total assets

 

5 446

5 446

 

 

 

 

Liabilities

 

 

 

Debt

–10 998

–7 528

–18 526

Total liabilities

–10 998

–7 528

–18 526

Assets

 

 

 

Policy loans

 

284

284

Mortgage loans

 

1 362

1 362

Other loans

 

653

653

Investment real estate

 

2 536

2 536

Total assets

 

4 835

4 835

 

 

 

 

Liabilities

 

 

 

Debt

–9 970

–10 136

–20 106

Total liabilities

–9 970

–10 136

–20 106

Policy loans, other loans and certain mortgage loans are classified as level 3 measurements, as they do not have an active exit market. The majority of these positions need to be assessed in conjunction with the corresponding insurance business. Considering these circumstances, the Group presents the carrying amount as an approximation for the fair value.

Investments in real estate are fair valued primarily by external appraisers based on proprietary discounted cash flow models that incorporate applicable risk premium adjustments to discount yields and projected market rental income streams based on market-specific data. These fair value measurements are classified in level 3 in the fair value hierarchy.

Debt positions, which are fair valued based on executable broker quotes or based on the discounted cash flow method using observable inputs, are classified as level 2 measurements. Fair value of the majority of the Group’s level 3 debt positions is judged to approximate carrying value due to the highly tailored nature of the obligation and short-notice termination provisions.