The new fair value disclosures
A snapshot of how public companies adopted
the disclosure requirements of ASU 2011-04
Executive summary
Beginning with quarters ended 31 March 2012, public companies were required
to provide several new disclosures related to their fair value measurements. For
many companies, the requirement to provide more detailed information about
the assumptions for their Level 3 measurements and the processes they have in
place to determine that these measurements are consistent with the fair value
framework in US GAAP posed the biggest challenge.
To help companies understand how their disclosures compare with those
of their peers, we analyzed the quarterly financial statement disclosures1
of 60 companies in various industries. We focused primarily on the new
disclosures required for Level 3 measurements (i.e., fair value measurements
determined using significant unobservable inputs). In doing so, we analyzed
the types of information that companies provided and how they presented
this information. We also looked at how companies complied with the
requirement to categorize within the fair value hierarchy items that are only
disclosed at fair value. We did not compare the consistency of the actual
unobservable inputs companies used to measure similar asset classes.
Not surprisingly, we found differences in the way companies complied
with the new disclosure requirements in a number of areas, including
the types of quantitative information companies chose to disclose
about their significant unobservable inputs (e.g., disclosing the range
of inputs used or the weighted average inputs for an asset class) and
the level of disaggregation at which they provided the information.
The disclosures were also consistent in some areas, including how
companies generally addressed pricing information from third-party
vendors, such as pricing services or brokers.
These disclosures may evolve over time as companies refine the
information they provide based on feedback they receive and
leading practices that emerge. This might include presenting
quantitative information in a way that makes it easier for financial
statement users to reconcile these new disclosures with other
parts of the financial statements.
We hope you find this publication helpful. Ernst & Young
professionals are available to answer any questions you may
have about the issues discussed in this publication.
1
Based on Form 10-Q filings for the quarterly period ended
31 March 2012
Contents
Background....................................................................1
Overview of the new Level 3 disclosure requirements.......... 2
Scope of companies reviewed..........................................4
Quantitative information about significant
unobservable inputs........................................................5
Level 3 valuation processes...........................................13
Sensitivity of Level 3 measurements to significant
unobservable inputs......................................................15
Assets and liabilities for which fair value is only
disclosed......................................................................17
Conclusion...................................................................18
Appendix......................................................................19
Banking.................................................................20
Asset management................................................28
Insurance...............................................................32
Energy...................................................................36
Real estate.............................................................40
Background
In recent years, the Financial Accounting Standards Board (FASB) has expanded disclosure
requirements related to fair value measurements. Beginning with the adoption of FAS 157,2
companies reporting under US GAAP have been required to make disclosures aimed at providing
financial statement users with information about (1) the extent they use fair value to measure
assets and liabilities, (2) the techniques, inputs and assumptions they use to measure fair value
and (3) the effect of fair value measurements on earnings or other comprehensive income. The
FASB has steadily increased the amount of information companies must disclose in response to
requests from financial statement users for companies to be more transparent about their fair
value measurements and the effect of these measurements on the financial statements. The
disclosures required by ASU 2011-043 represent the latest revision to the fair value information
presented in the footnote disclosures and are primarily related to Level 3 measurements.
2
Statement of Financial Accounting Standards No. 157, Fair Value Measurements (FAS 157), was issued in September
2006 and codified in Accounting Standards Codification (ASC) Topic 820, Fair Value Measurement (ASC 820), in 2009.
3
Accounting Standards Update No. 2011-04, Amendments to Achieve Common Fair Value Measurement and
Disclosure Requirements in U.S. GAAP and IFRSs (the ASU)
The new fair value disclosures
1
Overview of the new Level 3
disclosure requirements
The ASU requires companies to disclose:
• Quantitative information about the significant unobservable inputs used in
determining both recurring and nonrecurring Level 3 measurements
• A description of the valuation processes a company has in place for its
recurring and nonrecurring Level 3 measurements
• This may include information about the group within the company that is
responsible for the valuation policies and procedures, the methods and
frequency of the procedures in place for validating pricing models, the
processes for analyzing changes in fair value measurements from period to
period and how information from brokers or pricing services is evaluated
• A description of the sensitivity of recurring Level 3 fair value measurements
to changes in the unobservable inputs, if changing those inputs would
significantly affect the fair value measurement (only for public companies)
• Public companies are also required to describe any interrelationships between
the unobservable inputs and how these relationships may magnify or mitigate
the effect of changes to these inputs on the fair value measurement
ASU 2011-04 does not provide specific guidance on what quantitative
information should be disclosed to meet the requirement described in the first
item above. Instead, it includes an example of the type of information companies
may disclose.4 The ASU also provides examples of the types of information
companies may disclose to meet the objective of the other items listed above.5
Consistent with the existing disclosure requirements in ASC 820, the new Level 3
disclosures apply only to items measured at fair value on the statement of financial
position after initial recognition and are to be presented by class of asset and liability.
4
ASC 820-10-55-103 through 55-104
5
ASC 820-10-55-105 and 55-106
2
Other new disclosure requirements
ASU 2011-04 also requires other new disclosures. For
example, public companies are required to categorize
within the fair value hierarchy fair value measurements
made solely for disclosure purposes. This publication
includes our observations on the hierarchy classification
of these items across the companies we analyzed, as well
as for certain industries.
Our analysis did not focus on the following new disclosures
provided by public companies because they require less
judgment:
• For recurring fair value measurements, the amount
of any transfers between Level 1 and Level 2 of the
fair value hierarchy, along with the reasons for the
transfer and the company’s policy for determining when
transfers are deemed to have occurred (companies
previously were required to disclose these transfers only
if they were deemed to be significant)
• Situations where a nonfinancial asset was measured
assuming a highest and best use that differed from its
current use and why this was the case
• A company’s accounting policy decision to use the
“measurement exception” when determining the fair
value of financial assets and liabilities with offsetting
risks as provided for in ASC 820-10-35-18D
The new fair value disclosures
3
Scope of companies
reviewed
We analyzed the fair value disclosures in the 31 March 2012 Form 10-Qs of
60 companies in various industries, including banking, asset management, insurance
and energy, where Level 3 measurements tend to be more prevalent. We also
reviewed the disclosures of media and entertainment, health care, automotive
and diversified services companies that reported Level 3 measurements6 as
well as certain types of real estate companies. Companies in the life sciences,
telecommunications, retail and consumer products and technology sectors were
excluded from our analysis because they generally reported only a limited number
of Level 3 items (e.g., impairment of long-lived assets, if applicable).
Slightly more than half of the companies we reviewed are Fortune 500 companies.
We also included mid-sized companies in our analysis to get a more complete picture
of how public companies of various sizes adopted the new disclosure requirements.
The composition of our sample by industry is illustrated below.
Sample by industry
industry
Banking
23%
Energy
23%
Other
9%
Real estate
10%
Asset management
20%
Insurance
15%
f quantitative inputs
In the Appendix, we highlight specific observations by industry. We also provide
additional information about the characteristics of the companies we analyzed.
Tabular
90%
6
4
Narrative
5%
Companies from these industries are grouped in a category
called “Other” for the purposes of this
publication (see chart).
Hybrid
5%
Quantitative information about
significant unobservable inputs
Population by industry
Banking
23%
Energy
23%
Companies generally complied with the requirement to disclose quantitative
information about their significant unobservable inputs in tabular format.7
Other
A few companies
presented this
9% that had limited Level 3 measurements
Asset management
information in narrative form. A small percentage opted20%
for a hybrid approach,
providing a table of inputs for a subset of their Level 3 measurements and
disclosing theReal
restestate
in a narrative.
10%
Insurance
15%
Presentation of quantitative inputs
Presentation of quantitative inputs
Tabular
90%
Narrative
5%
Hybrid
5%
Fair value amounts
7
ASC 820-10-50-8 states that “[a] reporting entity shall present the quantitative disclosures
required by this Topic in a tabular format.”
Disclosed
in table
86%
We found differences in theNotway
companies complied with the
disclosed
in table
new disclosure requirements in a14%number of areas, including the
types of quantitative information companies chose to disclose
about their significant unobservable inputs and the level of
disaggregation at which they provided the information.
The new fair value disclosures
5
Population by industry
Banking
23%
Types of quantitative information provided
Energy
23%
Other
9%
Real estate
While not explicitly required, ASC 820-10-55-103 provides an example of how
10%
companies might comply with the requirement to provide quantitative information
about their significant unobservable inputs. This example includes the following
types of quantitative information for each class of assets or liabilities:
Presentation of quantitative inputs
• The Level 3 fair value amounts
Asset management
20%
Insurance
15%
• The range of inputs used
• The weighted average of the range of inputs
Tabular
90%
While many companies in our sample provided information that was consistent
with this example, others modified the types and amounts of quantitative
information they disclosed.
Of the companies that provided a tabular disclosure, the vast majority disclosed
the Level 3 fair value amounts by class within the tables, as the chart on the
right illustrates.
Fair value amounts
or (internal
only) companies presented their fair value
Fair
value amounts
However,
balances
in different ways. For example, for a certain class of
assets, some companies provided subtotals of the fair
18 valuation technique (e.g., discounted
value amounts by
cash flow method, market approach), while others
Disclosed
14
provided only totals, leaving it unclear whether both
in table
86%
techniques were used to value the entire class or
different techniques were used for subsets of the class.
6
In addition, certain companies included in their tables
fair value amounts for items valued using broker quotes
or pricing services, while other companies did not.
PwC
DT
Disclosures of weighted averages also varied, as the
following chart indicates.
Range of inputs and weighted average
nputs and weighted average
Provided weighted
average and range
of inputs
44%
Provided only
range of inputs
54%
Provided only
weighted average
2%
6
ed by entity
Disclosed only
fair value amounts
KPMG
Narrative
5%
Hybrid
5%
Not disclosed
in table
14%
While many companies provided both the range of significant unobservable inputs
used and the weighted average of those ranges, more than half of the companies
in our study — regardless of size, industry or amount of Level 3 holdings — provided
only the range of inputs (i.e., they excluded the weighted average).8 The decision
to provide weighted averages did not seem to depend on how wide the company’s
input ranges were. That is, the range of inputs used by companies that did not
provide weighted averages was not noticeably “tighter” than the range disclosed
by companies that provided this information. Even when the range for a certain
input was very wide (e.g., use of loss severity assumptions from 0% to 100%),
many companies did not provide the weighted average.
One company provided weighted average inputs by class of asset and liability but
did not disclose the range of inputs used.
From an industry perspective, the insurance companies in our sample were the
most consistent in disclosing both the range of inputs and the weighted average of
those inputs, followed by real estate and energy companies, as the following chart
indicates. A smaller percentage of companies in asset management and banking
provided weighted average information compared with our overall sample.
Percentage of industry disclosing weighted averages
Percentage of industry disclosing weighted averages
Insurance
75%
Real estate
60%
Energy
50%
Asset management
36%
Banking
36%
Other
8
20%
Companies that had only one Level 3 instrument (or one Level 3 instrument per class) for which
weighted average information would not be meaningful were not considered as part of this observation.
Assets
$25 billion to
More$100
than
billionhalf of the companies
29%
we reviewed did not provide
Less than $25 billion
42%
weighted average information.
More than
$100 billion
29%
Banks - Level of aggregation for quantitative information
Less detailed
The new fair value disclosures
7
Assets
$25 billion to
$100 billion
29%
Less than $25 billion
42%
More than
$100 billion
29%
Valuation techniques and inputs
We-noted
more
consistency in the
techniques
companies used for the
Banks
Level
of aggregation
forvaluation
quantitative
information
same or similar classes of assets and liabilities. For many industries, a discounted
cash flow (DCF) approach was the most common technique used
fordetailed
valuing Level 3
Less
39%a combination
measurements. In some industries, we noted that many companies used
of techniques (e.g., income and market approach) in valuing certain Level 3 items
(e.g., the measurement ofSame
equity
by asset management companies).
as investments
other
Level 3 disclosures
More detailed
46%
In contrast, practice was mixed
for the number and types of inputs
disclosed. For
15%
example, of the seven banks in our study that held residential mortgage-backed
securities (RMBS), most disclosed inputs related to default rate, prepayment rate,
loss severity and discount rate, as illustrated below.
Number of banks providing the same types of inputs (RMBS)
Number of banks providing the same types of inputs (RMBS)
Discount rate
7
Prepayment rate
7
Loss severity
5
Default rate
5
However, the number and types of inputs disclosed by the six of these seven banks
that also held commercial mortgage-backed securities (CMBS) were more varied.
Number of banks providing the same types of inputs (CMBS)
Number of banks providing the same types of inputs (CMBS)
Discount rate
5
Prepayment rate
4
Loss severity
4
Default rate
2
As illustrated above, while these banks generally presented the same four types
of inputs for their RMBS portfolio, several of them disclosed only two types of
inputs forof
their
CMBS holdings
(e.g., discount
rate and
lossof
severity
Percentage
companies
providing
the same
types
inputsor discount
rate and prepayment speed).9 (See the banking discussion in the Appendix for
Discount rate
additional details.)
Prepayment rate
Cost to service
100%
100%
50%
9
The number and types of inputs presented by companies may differ for several reasons. For example,
some companies might exclude certain assumptions based on significance to the measurement, while
other companies may have used valuation techniques that require fewer assumptions (e.g., certain
Valuation
techniques
used
securities
risks may
be captured inbanks
the discount
ratefor
instead
of through other explicit assumptions).
8
DCF analysis
Comparable market data
9
6
Level of aggregation
ASC 820 requires companies to present disclosures for each class of assets and
liabilities measured at fair value.10 The guidance states that companies should
determine the appropriate classes of assets and liabilities on the basis of the
nature, characteristics and risks of the assets and liabilities, noting that further
disaggregation might be required for Level 3 fair value measurements. To assess
whether they have met the objective of the disclosure, ASC 820-10-50-1A
indicates that companies should consider, among other factors, the level of detail
necessary to satisfy the disclosure requirements and how much aggregation or
disaggregation to undertake.
The following chart shows that the majority of the companies in our sample
provided quantitative information about their Level 3 inputs at the same level
of aggregation as their other disclosures, while several companies provided this
information at a more aggregated level. However, more than a quarter of the
companies we reviewed provided quantitative information about their significant
unobservable inputs at a more disaggregated level than their other Level 3
disclosures (e.g., the level of disaggregation used in the Level 3 rollforward).
Many of the companies providing
Level of aggregation
Level sector.
of aggregation
greater detail were in the energy
These companies often presented
quantitative information about the
inputs used in measuring their Level 3
commodity derivatives by commodity
Same as other
type (e.g., oil, electricity, natural gas).
Level 3 disclosures
More detailed
28%
54%
Across many industries, we observed
diversity in the level of aggregation
Less detailed
at which the significant unobservable
18%
inputs were presented. For example,
certain companies grouped all of their
fixed income securities into one line item (i.e., debt securities), while others split
their fixed income portfolios
intocompanies
multiple classes
(e.g., government
securities,in their footnotes
How
described
valuation processes
non-US debt securities and different classes of asset-backed securities by
underlying collateral type).11
Provided a
separate section
56%
Embedded in other
disclosures
44%
10
ASC 820-10-50-2
11
It is important to note that the diversity in levels of aggregation among companies may result from
differences in their portfolio holdings. For example, a financial institution that holds only one type of
RMBS might reasonably present its Level 3 disclosures at a different level of disaggregation from an
institution that holds RMBS with multiple types of collateral (e.g., prime, subprime and Alt-A).
Percentage of industry that discussed interrelationships
The new fair value disclosures
9
Banking
Insurance
44%
Range of inputs and weighted average
Information not developed by the reporting entity
The ASU clarifies that companies are not required to create quantitative information
about the significant unobservable inputs used to measure Level 3 assets and
Provided only
liabilities if those inputs are not developed by the company, as may be the case
range of inputs
when broker quotes or third-party pricing services are used.54%
However, companies
cannot ignore information about these inputs that is reasonably available.12
The companies in our sample that
specifically indicated they relied on
Inputs not developed by entity
broker quotes or pricing services for
Inputs not developed by entity
their Level 3 measurements generally
concluded that the significant
unobservable inputs for these items
were not reasonably available. In these
instances, most companies did not
provide any quantitative information
Excluded from table
about these measurements (see
71%
chart). A few companies in this
situation disclosed the range of quotes
or prices they obtained from brokers
and other third parties, but did not
provide quantitative information
about the significant unobservable
inputs that may have been used in developing the quoted prices. However, some
companies disclosed the adjustments they made to information obtained from
third parties as an unobservable input.
12
10
ASC 820-10-50-2(bbb)
Provided weighted
average and range
of inputs
44%
Provided only
weighted average
2%
Disclosed only
fair value amounts
(no other quantitative
information)
17%
Disclosed range
of third-party
information obtained
12%
In addition, practice was mixed on the amount of detail companies provided to
reconcile the quantitative information about their unobservable inputs to other
disclosures, such as the Level 3 rollforward or the fair value hierarchy table. For
many companies that relied on third-party information and opted to exclude
the fair value amounts from the Level 3 inputs table, we found that reconciling
between the different disclosures was often very challenging.
However, certain companies appeared to have made a conscious effort to provide
financial statement users with the ability to more easily reconcile their tabular
disclosures about unobservable inputs to the other footnote disclosures. Although
they did not disclose the inputs in the table, these companies provided at least the
fair value balances represented by broker quotes or pricing services by class of
asset or liability directly in the table (or as a footnote to the table), similar to the
example below.
Example 1: Incorporating information not developed by the reporting entity
Valuation technique
Significant
unobservable
input
Range of
inputs
Weighted
average
Discounted cash flow
Discount rate
0.5% - 4.0%
2.0%
n/a
n/a
n/a
($ in millions)
Government, health care and other
revenue bonds
Fair
value
$400
$85
Vendor priced
$485
Note: Numbers provided for illustration purposes only.
One company in our sample provided a separate table by class of assets and
liabilities, distinguishing between Level 3 items for which information was
readily available (e.g., internally modeled valuations) and Level 3 items for which
information was not readily available (e.g., investments valued using broker
quotes). This presentation made it very easy to link the information provided
about unobservable inputs to the rest of the fair value disclosures.
Companies that relied on information
from third-party pricing services and
brokers generally concluded that
quantitative information about the
significant unobservable inputs
was not reasonably available.
The new fair value disclosures
11
Other observations
Three companies in our sample
reported material Level 3 contingent
consideration liabilities (or earnouts).
We noted that all of these companies
provided at least some quantitative
information about the significant
unobservable inputs used in
determining these measurements
as required.13 While one company
provided this information in a
tabular format, the other two did
so in a narrative format. We noted
consistency in the valuation techniques
used, as all of the companies in
our sample used some type of DCF
analysis to estimate the fair value of
these liabilities. In addition, all three
companies disclosed the discount rate
they used in their DCF analysis, with
two of the companies also disclosing
quantitative information about the
growth rate of the underlying metric.
However, no specific quantitative
information about the probability or
likelihood of achieving the relevant
targets or thresholds was provided.
13
12
Although not within the scope of our analysis,
we noted a number of companies in the life
sciences and technology industries that
reported Level 3 contingent consideration
obligations. In contrast to the companies in
our study, many of these companies did not
provide any quantitative information about
the significant unobservable inputs used
to measure these liabilities. Instead they
disclosed a strictly qualitative discussion of the
valuation approaches applied (e.g., probabilityadjusted discounted cash flows, option pricing
techniques, simulation of expected annual sales)
and the different types of assumptions used
(e.g., probability of achieving the agreed upon
milestones, estimated sales, discount rate).
Level 3 valuation processes
In accordance with the new requirements in the ASU, companies must now describe
their valuation processes for Level 3 fair value measurements. An example in the
ASU14 illustrates the following types of information that companies may provide to
comply with this requirement:
• Description of groups responsible for valuation policies and procedures and the
internal reporting procedures in place
• Frequency and methods for calibration, back testing and other testing
procedures of pricing models
• Process for analyzing changes in fair value measurements from period to period
• Process for evaluating third-party information from third parties, such as
Level of aggregation
brokers or pricing services
• Methods to develop and substantiate the unobservable inputs used in a fair
value measurement
More detailed
28%
Same as other
Most of the companies in our study appear
to have provided some incremental
Level 3 disclosures
footnote disclosures about their Level 3 valuation
54% processes. As the following
chart shows, the majority of these companies created a separate valuation
process section in either the fair value measurement or significant accounting
policies footnote. Others incorporated a description of their valuation processes Less detailed
18%
in their existing discussion about the valuation techniques and inputs they used
for Level 2 and Level 3
measurements. Certain
How companies described valuation processes in their footnotes
companies in our sample
How companies described valuation processes in their footnotes
did not appear to address
their valuation processes
for Level 3 measurements
in the footnote disclosures,
Provided a
although some provided this
separate
section
information within the critical
Embedded in other
56%
accounting policies section of
disclosures
Management’s Discussion and
44%
Analysis (MD&A).
Percentage of industry that discussed interrelationships
Banking
14
ASC 820-10-55-105
50%
Insurance
Asset management
Real estate
44%
The new fair value disclosures
42%
33%
13
The amount of detail and the types of information companies provided about
their valuation processes varied significantly. Not surprisingly, financial services
companies with sizable Level 3 holdings generally described their policies and
internal reporting procedures in more detail. However, regardless of size or
industry, the companies in our study generally did not provide detailed disclosures
about the manner and frequency by which they tested their pricing models or the
methods they used to develop and substantiate unobservable inputs.
For companies that relied on broker quotes and pricing services, we observed
mixed practice in the disclosures about their valuation processes, as well as the
processes themselves. For example, several financial institutions in our sample
stated that they used third-party pricing services or broker quotes to validate
the fair values of internally modeled financial instruments, while most other
companies indicated that such third-party information was the primary basis for
their valuations. We noted significant diversity in the manner and the amount of
detail companies used to describe their process for evaluating the information
they obtain from brokers and pricing services, with the large banking institutions
generally providing the most robust disclosures.
14
Sensitivity of Level 3
measurements to significant
unobservable inputs
ASU 2011-04 requires public companies to describe the sensitivity of their
recurring Level 3 fair value measurements to the unobservable inputs used, if
changing those inputs would significantly affect the fair value measurement.
There is no requirement to quantify the change to the unobservable input or the
effect of the change on the measurement, but companies are required to discuss,
at a minimum, the general effect on the measurement of those significant
unobservable inputs for which quantitative information was disclosed.
The majority of companies we reviewed provided a sensitivity analysis disclosure.
More than 70% of the companies that provided such a disclosure described
the directional impact of all the significant unobservable inputs for which they
disclosed quantitative information. We noted that most of the companies in
this group patterned their discussion on the example provided in the ASU.15
A few incorporated the sensitivity analysis directly into their quantitative inputs
disclosure by adding an extra column in the table (or by footnoting each input)
and describing how changes to the input would directionally affect fair value.
Regardless of how the information was presented, we noted mixed practice in
the amount of detail companies disclosed about the sensitivity of their Level 3
measurements, as illustrated by the chart below.
The most robust sensitivity
Narrative sensitivity analysis
analysis disclosures in our
Narrative
sensitivity
analysis
sample were generally
provided by large banks
and insurance companies.
These companies typically
incorporated all of the
Described directional
significant unobservable
effect of all significant
unobservable inputs
inputs they disclosed and,
73%
in certain cases, provided
additional color about
the assumptions and the
underlying drivers of the
fair value measurement.
15
Described directional
effect of some significant
unobservable inputs
19%
Provided generic
description
8%
Interrelationships among inputs
ASC 820-10-55-106
The new fair value disclosures
Described
interrelationships
39%
Did not disclose
15
For example, virtually all of the banks that had Level 3 RMBS described the
directional effect that changes in the default rate, prepayment rate, loss severity
and discount rate assumptions would have on the fair value measurement.
Similarly, almost all insurance companies that held guaranteed minimum benefits
described how mortality rates, lapse rates, utilization rates and withdrawal
rates, among others, would directionally affect the fair value of those embedded
derivatives. One insurance company also discussed how market volatility, longterm interest rates and credit risk might affect these assumptions, the overall fair
value measurement and even the company’s net income.
In contrast, we noted that companies in other industries tended to provide less
Levelrobust
of aggregation
disclosures. For example, about a quarter of the companies that provided
the sensitivity analysis disclosure highlighted the effect of changes to some, but
not all, of the significant unobservable inputs provided inMore
theirdetailed
tabular disclosures.
In addition, a number provided only generic statements about
the sensitivity
28%
of their Level 3 measurements. For example, some companies indicated that,
Same as other
generally, aLevel
change
in any of the significant unobservable inputs may lead to a
3 disclosures
change in their fair54%
value measurements.
Public companies are also required to describe any interrelationships between
detailed
the unobservable inputs used and to discuss how thoseLess
interrelationships
18%
might magnify or mitigate the effect that changes in these inputs would have
on fair value. Among the companies in our sample that provided a sensitivity
analysis disclosure, we observed that less than 40% provided a discussion about
While
this requirement
is not
relevant
for companies that
How interrelationships.
companies described
valuation
processes
in their
footnotes
identified only one significant unobservable input for a certain class of assets
or liabilities or when a company determined that there are no interrelationships
between significant unobservable inputs, it appears that providing an explicit
description of the interrelationship among the inputs was not a key area of focus
Provided a
for many companies.
separate section
Embedded in other
56%
disclosures
The following chart illustrates the percentage of companies within
each industry
44%
that discussed the interrelationships between the significant unobservable inputs
used in the valuation of their Level 3 measurements. As illustrated, other than
banking, less than half of the companies in the industries we analyzed described
how their unobservable inputs may be interrelated.
Percentage of industry that discussed interrelationships
Percentage of industry that discussed interrelationships
Banking
50%
Insurance
44%
Asset management
42%
Real estate
Energy
16
33%
14%
Assets and liabilities for which
fair value is only disclosed
The ASU also requires public companies to categorize in the fair value hierarchy
those fair value measurements provided only for disclosure purposes (e.g., loans
carried at amortized cost whose fair values are required to be disclosed in
accordance with ASC 825-10-50-10).16
While all the companies in our sample complied with this requirement (where
applicable), they provided the information in different ways. We found a fairly even
split between companies that provided the hierarchy classifications as a separate
tabular disclosure and those that presented the information in narrative form.
The approach used seemed to depend primarily on the size and diversity of
the company’s financial instrument holdings. For example, the majority of
the financial services companies disclosed the fair value hierarchy categories
in a separate table, together with the carrying values and fair values of their
financial instruments. In contrast, most energy companies provided the hierarchy
classifications of their financial instruments in a narrative form, given the limited
number of financial instruments held.17
16
ASC 825, Financial Instruments
17
Primarily long-term debt carried at amortized cost whose fair values are required to be disclosed in
accordance with ASC 825
The new fair value disclosures
17
Conclusion
In adopting the new fair value disclosure requirements, public companies
disclosed different types of quantitative information about their significant
unobservable inputs and presented this information at varying levels of
aggregation. The amount of detail that companies provided about their valuation
processes also varied, in many instances, based on industry and the significance
of the company’s Level 3 measurements.
These disclosures may evolve as companies gain additional insight into the
disclosures made by their peers and refine the information they provide based
on leading practices. This may include presenting quantitative information
about significant unobservable inputs in a way that makes it easier for users to
reconcile this information to other parts of the financial statements. We hope this
publication will help companies as they develop their future disclosures.
Further enhancements to the new fair value disclosures may also stem from
comments received from the staff of the Securities and Exchange Commission
(or other relevant regulators) or additional transparency on the part of third-party
pricing services. For example, as some third-party pricing services introduce tools
providing more insight into their key assumptions, companies should continue to
assess what information they determine to be “reasonably available.”
User feedback may also play a role in the evolution of these disclosures. In this
regard, we believe it is important that users and preparers both understand the
objectives, and the limitations, of the new Level 3 disclosures. Some companies
question the usefulness of providing quantitative information about the
significant unobservable inputs used in a fair value measurement, given the level
of aggregation at which the information is presented. However, it is important to
remember that the objective of the disclosure is to provide enough information
for users to assess whether the company’s views about unobservable inputs differ
from their own and, if so, to decide how to incorporate this information into their
decisions. These disclosures are not intended to enable users of the financial
statements to replicate the company’s pricing models.18
We also expect users to compare the quantitative information a company
provides about its unobservable inputs over time to better understand changes in
management’s views about particular inputs and about changes in the market for
the assets and liabilities within a particular class.
18
18
Paragraph BC 86 in the Basis for Conclusions of ASU 2011-04
Appendix
The new fair value disclosures
19
Percentage of industry disclosing weighted averages
Insurance
Real estate
Banking
60
Energy
50%
Appendix Asset management
36%
Banking
36%
Banking
Other
Scope of companies reviewed
20%
We reviewed the new fair value disclosures of 14 banks —six global financial institutions and eight
national or regional banks. The majority of our sample was composed of larger commercial or
investment banks (i.e., those with assets of $25 billion and greater) because these institutions tend t
have bigger and more diverse Level 3 portfolios. However, we included a number of smaller banks
Scope of companies reviewed
whose material Level 3 positions consisted primarily of derivatives and certain nonrecurring Level 3
measurements,
such
as impaired loans and foreclosed assets. The distribution of our sample by tota
We reviewed the new fair value
disclosures of 14
banks:
Assets
assets
is
illustrated
below.
six global financial institutions and eight national or
regional banks. The majority of our sample
was composed
$25 billion to
Assets
By (i.e., those
total assets
of larger commercial or investment banks
$100 billion
$25 to $100 billion
29%
with assets of $25 billion and greater) because these
29%
institutions tend to have bigger and more diverse
Level 3 positions. However, we included a number of
Less
than
$25 billion
Less than
$25
billion
smaller banks whose material Level 3 holdings consisted
42%
42%
primarily of derivatives and certain nonrecurring Level 3
More than
measurements, such as impaired loans and foreclosed
Over $100 billion
$100 billion
29%
assets. The distribution of our sample by total assets is
29%
illustrated in the chart to the right.
Quantitative information about significant unobservable inputs used for recurring Level 3
Quantitative information
about significant unobservable inputs
measurements
Banks - Level of aggregation for quantitative information
Recurring Level 3 measurements
Derivatives
Derivatives
Less detailed
39%hold a much smal
Several banks in our study are derivatives dealers, while others are end-users that
portfolio
of derivatives
used
primarily
to users
hedgethat
their interest rate risk. We noted that the level of det
Several banks in our study are
derivatives
dealers, while
others
are end
about
the
unobservable
inputs
disclosed
varied
significantly
between these companies. Derivatives
hold a much smaller portfolio of derivatives used primarily to hedge their
Sameinterest
as other
dealers tended to provide more detailed
measurement
assumptions,
such as correlation and volatilit
disclosures
rate risk. We noted that the level of detail about the unobservable Level
inputs3disclosed
assumptions by derivative type. For example,
derivatives
dealers
in
our
study
disclosed
More
detailedinformation
varied significantly between these companies. Derivatives dealers tended 46%
to
about numerous unobservable inputs to value their interest rate and credit derivatives,
as illustrated
15%
provide more detailed measurement
below: assumptions, such as correlation and
volatility assumptions by derivative type.
For instance, certain derivatives dealers
in our study disclosed information about
Interest rate derivatives
Credit derivatives
numerous unobservable inputs to value
Upfront points
Correlation (IR/IR)
their interest rate and credit derivatives,
Number of banks
providing
the
same
types
of
inputs
(RMBS)
Correlation
Correlation (FX/IR)
similar to the illustration provided.
Spread to index
Discount
Long-datedrate
inflation rates
In contrast, the end-user banks in our
Yield
Prepayment
rate volatilities
Long-dated inflation
study provided more basic information,
Prepayment speed
Loss severity
5
such as the swap rates used for measuring
Long-dated
volatilities (IR, FX)
Default rate
long-dated positions.
Default
rate
5
Loss severity
Long-dated
swap rates
In contrast, the end-user banks in our study provided more basic information, such as the swap rates
used for measuring long-dated positions.
20
Residential mortgages and residential mortgage-backed securities
Seven banks in our study had Level 3 loans and securities backed by residential real estate and all
Residential mortgage-backed securities
Seven banks in our study had Level 3 securities backed by residential real
estate and all disclosed the discount rates and prepayment rates as significant
unobservable inputs, while all but one provided loss rate assumptions as well.
However, we saw mixed practice in the amount of detail banks provided about
these inputs. For example, while some banks expressed loss assumptions as one
factor (i.e., cumulative loss rate), others were more granular, providing cumulative
loss rates split into lifetime default rates and loss severity, or including a more
precise input such as cure given default. We also observed that the banks in
our sample sometimes used different descriptions (e.g., constant prepayment
rate, cumulative prepayment rate, lifetime prepayment rate, prepayment
speed and prepayment period) when referring to the same type of assumption
(i.e., prepayment risk), making comparisons between banks less straightforward.
Mortgage banking operations
Several banks in our study had significant mortgage banking operations, but
it was not clear whether or how interest rate lock commitments (IRLCs) were
presented in the quantitative inputs table.19 Three banks in our study explicitly
provided quantitative information about the inputs they used to determine the
fair value of their IRLCs in their tables, and all disclosed the fallout factor as a
significant unobservable input. Two of the three banks also disclosed quantitative
information about their servicing assumptions.20
19
We note that some banks consider IRLC valuations to be Level 2 measurements, while other banks
that classify them as Level 3 measurements might include IRLCs under a broader class of assets
(e.g., assets backed by residential real estate, derivatives).
20
For example, assumptions relating to estimated net servicing fees (i.e., servicing fees minus
servicing costs)
The new fair value disclosures
21
Discount rate
5
Prepayment rate
4
Loss severity
4
Default rate
2
Of the six banks in our study that
Percentage of banks providing the same types of inputs (MSRs)
Percentage of companies providing the same types of inputs
held mortgage servicing rights
(MSR), all provided quantitative
Discount rate
information about the discount
Prepayment rate
rates and prepayment rates used
to determine the fair value of
Cost to service
50%
these Level 3 measurements, as
the chart illustrates. However, we
noted mixed practice with respect
to the cost
to servicebanks
assumption,
which
only
Valuation
techniques
used for
securities
half of these banks provided.
Nonrecurring Level 3 measurements
DCF analysis
100%
9
Comparable market data
6
Impaired loans and foreclosed assets
Vendor pricing
5
Banks often have nonrecurring Level 3 fair value measurements related to impaired
internal
models
loans and foreclosed assets, as was the Other
case for
eight
of the banks in our sample.21 3
Below are specific points we observed related to how these banks disclosed
quantitative information about their significant unobservable inputs for these items:
• All eight banks in our sample that
had nonrecurring Level 3 measurements related
Strategy
to impaired loans and foreclosed assets explicitly indicated that they used thirdparty appraisals to measure the fair value of the loans’ underlying collateral, but
provided no specific information about the unobservable inputs. That is, none of
Investment
these banks provided information about the underlying assumptions
used in the
management and
other services
appraisals that may have been based on unobservable information.
Investment
management only
42%
42%
• Banks may adjust appraisal values for various reasons, including (1) estimated
changes in value between the financial reporting date and the appraisal date or
(2) historical experience of amounts realized upon sale compared with appraised
values. Five of the eight banks in our sample disclosed adjustments they
Assets
under management
made to the appraised amounts
as significant
unobservable inputs to the fair
value measurement. While we noted some consistency in the way many banks
Less
disclosed their adjustments (i.e., expressed as a percentage of
thethan
appraisal
$100 billion
values), the description of the nature of the adjustments varied42%
by company.
• While costs to sell are not technically part of the fair value measurement, we
noted that three of the eight banks disclosed an adjustment for costs to sell
in the Level 3 inputs table.22 One other bank included the DCF approach as a
valuation technique in its Level 3 table for certain impaired loans; however,
impairments determined using a DCF analysis typically do not represent fair
value measurements since the impairment is based on cash flows discounted at
the loan’s effective interest rate as required by ASC 310.
21
The accounting guidance allows banks to use the fair value of collateral as a practical expedient
for measuring loan impairment. When a bank expects to foreclose on the collateral, impairment is
measured using fair value of the loan’s collateral less costs to sell the collateral. Once collateral is
foreclosed, it is transferred from the loan portfolio to “other real estate owned” at fair value. After
foreclosure, the asset is measured at the lower of cost or fair value less costs to sell.
22
ASC 310, Receivables, requires the net carrying value of the assets to reflect net realizable value,
which is the fair value of the collateral less costs to sell.
22
100%
BDCs
16%
$100 billion to
$500 billion
25%
More than
$500 billion
33%
Number of banks providing the same types of inputs (CMBS)
Discount rate
5
Prepayment rate
4
Loss severity
4
Default rate
2
Valuation techniques
We noted that the banks we reviewed generally used similar valuation techniques
Percentage of companies providing the same types of inputs
for the same classes of assets. For example, out of the 12 banks in our study
that had securities
categorized in Level 3, a DCF analysis was the most common
Discount rate
100%
technique used. Other techniques included market comparables, vendor pricing
Prepayment rate
100%
or other
internal models, as the following chart illustrates. We also noted that
several banks
used a DCF approach to measure their
Cost tothat
service
50% securities also used one
of the alternative techniques listed below in combination with their DCF analysis.
Valuation
techniques
banks
used
forfor
securities
Valuation
techniques
banks
used
securities
DCF analysis
9
Comparable market data
6
Vendor pricing
5
Other internal models
3
Compared with other industries, banks were less likely to use third-party or
Strategy
vendor pricing as their primary valuation technique and instead used thirdparty information as corroborative evidence for their fair value
measurements.
Investment
onlyvaluation
Of the banks in our sample that used third-party pricingmanagement
as a primary
42%
Investment
technique for at least some
of their Level 3 measurements, only one disclosed
management and
any quantitative information
about the significant unobservable inputs, and
other services
that was limited to a subset42%
of the portfolio where this information was deemed
to be reasonably available. To help financial statement
users understand the
BDCs
16%the unobservable inputs
information that was presented, the bank clarified that
disclosed represented a composite summary of the information it was able to
obtain
for certain
securities. This is because only certain third-party pricing
Assets
under
management
services provided the assumptions they used and in some
this information
$100 cases
billion to
was available for only a limited number of securities. $500 billion
Less than
$100 billion
42%
25%
More than
$500 billion
33%
The new fair value disclosures
23
Energy
50%
Asset management
36%
Banking
36%
Other
20%
Level of aggregation
Given the uniqueness of their portfolios, it can be difficult to compare the level
of disaggregation banks use when making their fair value disclosures. However,
we observed that larger banks tended to provide information about their Level 3
assets and liabilities at more disaggregated levels because they generally held
a broader range of Level 3 positions. For example, we noted that several of
Assets
$25 billion to
these banks disaggregated their Level 3 derivative portfolios by underlying risk
$100 billion
(e.g., interest rate, credit, foreign exchange, commodity). In contrast, many of the
29%
smaller banks had only one type of derivative (i.e., interest rate derivatives), so
further disaggregation by underlying risk was not relevant.
Less than $25 billion
We also noted mixed practice in the level of aggregation many banks used to 42%
More than
present quantitative information about the significant unobservable inputs used
$100
billion
in their Level 3 measurements compared with their other fair value disclosures
29%
(e.g., the Level 3 rollforward). While most banks presented all Level 3 disclosures
at a consistent level of disaggregation throughout their fair
value disclosures, we observed some that provided less
Banks — Level of aggregation for quantitative information
- Level
detail and a few that provided more whenBanks
disclosing
their of aggregation for quantitative information
unobservable inputs, as the chart to the right illustrates.
Less detailed
39%
For example, a few banks in our study combined separate
classes of debt into one line when disclosing quantitative
information about the inputs used to value these securities.
Same as other
Another bank aggregated different types of mortgageLevel 3 disclosures
backed securities (MBS) when disclosing unobservable
More detailed
46%
inputs, despite the fact that in its other fair value
15%
disclosures (e.g., the fair value hierarchy table or the Level 3
rollforward) these MBS are broken down into several classes
(i.e., prime, subprime and Alt-A). Presumably, banks chose to aggregate certain
classes of assets because the significant unobservable inputs used in measuring
the instruments within the asset classes were deemed to be similar, but no specific
Number of banks providing the same types of inputs (RMBS)
explanation was provided.
Discount rate
In contrast, a few banks chose to provide quantitative information about
Prepayment
their significant unobservable inputs at a more granular
level thanrate
their other
Level 3 disclosures. For example, one bank in our study provided
disaggregated
Loss severity
information about its asset-backed securities (ABS) portfolio, distinguishing the
Default
significant unobservable inputs by collateral type (e.g., auto
loans rate
and leases,
dealer floor plan, other commercial and consumer). Presenting the information
in this manner provided additional transparency about the types and ranges
of inputs used for each type of ABS, which was useful given the variety of the
collateral and the securitization structures across the classes.
24
5
5
We also observed some diversity in the way banks in our study disaggregated
the quantitative unobservable inputs for certain types of assets compared with
their other Level 3 disclosures. For example, two banks in our sample presented
the significant unobservable inputs used for all assets backed by residential real
estate (e.g., residential mortgage loans, RMBS) separately from those backed by
commercial real estate (e.g., commercial mortgage loans, CMBS). In contrast,
these assets were disaggregated between loans and securities, but not collateral
type, in the Level 3 rollfoward and hierarchy disclosures.
Valuation processes
Given their exposure to interest rate, liquidity and credit risks, many banks
maintain robust valuation groups and processes as part of their overall risk
management function. This was evident in our review of the disclosures made
by many of the larger banks in our sample, which tended to provide more
detail about their valuation processes. For instance, one bank in our study
provided enough detail to clearly distinguish between its processes for internal
model valuations (including model validation, benchmarking against market
transactions or other market data and backtesting key assumptions) and those
used for valuations based on third-party vendors (where its processes included
comparisons across vendors and internal corroboration of prices and key inputs
using available market data).
The following points illustrate the types of information the banks in our study
disclosed about their valuation processes:
• The groups responsible for valuation policies and procedures and their
reporting lines
• Description of the independent groups responsible for model validation and the
frequency of reviews performed
• The frequency of Valuation or Risk Committee meetings where the company’s
Level 3 measurements are reviewed and discussed
• Process for benchmarking valuations to similar products and validation of fair
value measurements using actual cash settlements
• Daily review and explanation of recorded gains and losses
• Procedures performed to validate third-party pricing information
• Comparison to other pricing vendors
• Variance analysis of prices (e.g., analysis of significant changes in prices over
a defined time period)
• Corroboration of pricing information by reference to other independent
market data such as market transactions or relevant benchmark indices
• Review of pricing information by personnel familiar with current market
conditions
• Independent review of valuations with material exposures
• Due diligence procedures performed on third-party pricing providers
The new fair value disclosures
25
Fair value hierarchy categorization of items for which fair
value is only disclosed
Many banks carry a portfolio of held-to-maturity (HTM) securities. Historically, these
portfolios tend to contain investments associated with lower risk (e.g., agency MBS,
municipal bonds) than the banks’ available-for-sale and trading portfolios, which are
carried at fair value on the statement of financial position. A majority of the banks in
our study classified their HTM securities as Level 2. Other items generally classified
as Level 2 included deposits, accrued interest and borrowings. The banks in our
study generally classified their subordinated debt as Level 3.
We noted that loans held for investment were generally categorized as Level 3,
while loans held for sale were classified as Level 2.
For the banks in our sample, Level 1 classification was generally limited to cash
and cash equivalents.
26
ASC 820 states that companies should
Of thethe
companies
we classes
analyzed,
banks that
determine
appropriate
of assets
and
significant
Level
3 positions
provided
liabilities held
on the
basis of the
nature,
characteristics
of the and
mostliabilities,
detailed noting
disclosures
and risks ofsome
the assets
that
about theirmight
valuation
processes.
further disaggregation
be required
for
Level 3 fair value measurements.
The new fair value disclosures
27
Discount rate
Default rate
payment rate
5
2
4
Loss severity
4
Default rate
2
of companies providing the same types of inputs
Discount rate
Asset management
f companies
payment
rate
providing the same types of inputs
Discount
rate
ost to service
50%
payment rate
100%
100%
100%
100%
chniques
banks used for securities
ost to service
50%
Scope of companies reviewed
DCF analysis
9
Webanks
reviewed
the disclosures
of 12 companies in the asset management industry.
hniques
used
for securities
e marketOur
datasample includes companies that provide investment management
6
services
and capital markets services, such as fund administration, financial markets
DCF analysis
Vendor
pricing
5
advisory and mutual fund related services. In addition to investment management
companies,
we also included business
eternal
market
data
models
3 development companies6(BDCs). The following
chart illustrates the composition of our sample by strategy or business type.
endor pricing
5
ternal models
Strategy
3
Investment
management only
42%
Investment
management and
Investment
other services
management
only
42%
42%
Investment
BDCs
management and
16%
other services
42%
We selected a diverse group of companies,BDCs
both in terms of investment strategy or
r management
focus (e.g., distressed debt, real estate, private
16% equity) and size, as illustrated below.
$100 billion to
$500 billion
Assets under
management
Less
than
25%
management $100 billion
42%
$100 billion to
$500
billion
More
than
Less than
25%billion
$500
$100 billion
33%
42%
More than
$500 billion
33%
28
9
Quantitative information about significant unobservable inputs
While almost all of the asset management companies in our sample provided the
range of inputs for their Level 3 instruments in tables, only about a third disclosed
weighted averages. Even in cases where very wide input ranges were disclosed
(e.g., recovery rates ranging from 0% to 100%, long-term growth rates from
negative 1% to 56%), some companies excluded weighted average information,
limiting the ability of financial statement users to assess the inputs used for these
asset classes.
We also observed diversity in the significant unobservable inputs the companies in
our sample disclosed for similar classes of assets. Although all of the companies
in our sample that used a DCF approach provided the range of discount rates
used (or an equivalent input, such as market yield or credit spread), the amount
of detail about the other significant unobservable inputs varied. The following
illustration highlights an example of the diversity around the inputs the companies
in our sample disclosed when using a DCF approach to measure the fair value of
debt securities.
Inputs by Company A
Inputs by Company B
Discount rate
Discount rate
19
Revenue growth rate
Exit multiple
Exit capitalization rate
Default rate
Recovery rate
Prepayment rate
The disparity in the types and number of inputs for which quantitative information was disclosed
appears to stem, atThe
least
in part, from
diversity
we observed
thewhich
levelquantitative
of aggregation at which
differences
in thethe
types
and number
of inputsinfor
the information is presented
discussed
That
is, companies
that
information(as
was
disclosedfurther
appearsbelow).
to stem,
at least
in part, from
thepresented
diversity their
disclosures at higher
of aggregation
to disclose
a greater
number of
for (as
each asset
welevels
observed
in the level oftended
aggregation
at which
the information
is inputs
presented
class, as different types
of
inputs
may
have
been
used
to
measure
the
wide
variety
of
securities
discussed further below). That is, companies that presented their disclosures at
encompassed within
the asset
higher
levelsclass.
of aggregation tended to disclose more inputs for each asset class,
as different types of inputs may have been used to measure the wide variety of
In contrast, the types of inputs companies disclosed when applying the market approach (e.g., when
securities encompassed within the asset class.
valuing their equity investments) were more consistent. For example, companies that used a market
approach, such as the guideline company method, almost always disclosed the EBITDA24 multiples (or
new fair value disclosures
other similar earnings multiples) they used, together with some type of valuation adjustmentThe
(e.g.,
discount for lack of marketability or a control premium depending on the nature of the instrument).
29
We noted more consistency in the types of inputs asset management companies
disclosed when applying the market approach to value their equity investments.
Here, companies generally disclosed the EBITDA23 multiples (or other similar
earnings multiples) used in the valuation along with any valuation adjustments
that may have been incorporated (e.g., discount for lack of marketability or a
control premium depending on the nature of the instrument).
Not surprisingly, a large number of the companies in our sample relied heavily
on broker quotes or pricing services to determine their fair value measurements
for certain asset classes. Eight companies in our sample used third-party pricing
information as their primary basis for determining the fair value of certain Level 3
debt securities. It appears that all eight companies determined that the inputs
used to value these securities were not readily available. None of them provided
quantitative information about the unobservable inputs underlying the third-party
prices or quotes.
In addition, only three asset managers in our study disclosed the fair value
amounts of Level 3 measurements that were based on third-party information.
As a result, it was difficult to reconcile the information in many companies’
quantitative input disclosure tables with their other Level 3 disclosures.
Level of aggregation
The majority of asset management companies we reviewed presented
quantitative information about their significant unobservable inputs at the same
level of aggregation as their other Level 3 disclosures (see chart). None of the
companies in our study presented information about significant unobservable
inputs at a more granular level than the classes disclosed elsewhere, while close
to 30% presented their quantitative inputs table at a higher level of aggregation.
Asset managers — Level of aggregation for quantitative information
rs - Level of aggregation for quantitative information
Less detailed
27%
Same as other
Level 3 disclosures
73%
23
30
Earnings before interest, taxes, depreciation and amortization
Assets
Property
and
casualty
$25 billion to
$100 billion
22%
In addition, the level of aggregation that asset management companies used to
present their asset or liability classes varied significantly, making comparisons
between companies very challenging. For example, we observed that companies
classified securities backed by real estate, such as CMBS, in a number of different
asset classes as illustrated below.
Some asset management companies presented quantitative information
about their significant unobservable inputs at very broad levels of aggregation
(e.g., debt instruments), usually combining different types of
securities into one class. For example, one company
included bank loans, securities backed by real
Commercial
Debt
real estate
instruments
estate investments and life settlement contracts
d bt securities
debt
iti
in one asset class. As a result, certain of the
significant unobservable inputs provided for
Loans and
Instruments
Asset-backed
the asset class are not directly relevant to
securities backed
backed by
securities
a portion of the fair value balance disclosed
by real estate
real estate
(e.g., information about the duration and
Real estate-oriented
life expectancy inputs used to value life
Structured
investments
products
settlement contracts is unrelated to securities
backed by real estate investments).
Valuation processes
The majority of asset management companies in our study provided additional
information about their valuation processes for Level 3 measurements as required
by the ASU. These companies generally disclosed information about the groups
responsible for valuation (e.g., independent investment and valuation teams) and
provided a description of the internal review procedures in place to validate the
reasonableness of their valuations. However, most companies did not disclose much
information about how frequently their valuation models were tested and reviewed.
A majority of the asset managers in our study that used information from thirdparty pricing services or brokers indicated that their valuations were primarily
based on this information and disclosed the procedures they had in place to assess
the reasonableness of this information, including:
• Independent validation of pricing information obtained from third-party sources
• Monthly review of price changes relative to overall market trends and credit analysis
• Price variance analysis, including investigation of unusual or unexpected
pricing changes
• Backtesting when relevant information is available
• Review of adjustments made to third-party pricing information by appropriate
level of management (e.g., Valuation Committee)
The new fair value disclosures
31
Assetmanagers
managers--Level
Levelof
ofaggregation
aggregationfor
forquantitative
quantitative information
information
Asset
Insurance
Lessdetailed
detailed
Less
27%
27%
Sameas
asother
other
Same
Level33disclosures
disclosures
Level
73%
73%
Scope of companies reviewed
We reviewed the disclosures of nine insurance companies that provide life
insurance and property and casualty insurance. Most are Fortune 500 companies,
with more than half holding assets greater than $100 billion. We also included
some medium-sized and smaller insurance companies, as illustrated below.
Company type
Assets
Companytype
type
Company
Life
Life
insurance
insurance
67%
67%
Assets
Assets
Property
Property
and
and
casualty
casualty
insurance
insurance
33%
33%
More
Overthan
$100billion
billion
$100
67%
67%
Many insurance companies issue either variable annuity products or investmenttype
contracts
that include
embedded
derivative
guaranteed
Number
ofinsurance
insurance
companies
providing
theinstruments
sametypes
types(e.g.,
ofinputs
inputs
(GMBs)
Number
of
companies
providing
the
same
of
(GMBs)
minimum benefits), which most of the companies in our study classified as
Level 3 measurements.
Lapserate
rate
Lapse
55
Utilizationrate
rate
Utilization
• Structured securities
• Certain corporate
bonds
Volatility
Volatility
• Certain equity securities
33
• Certain over-the-counter (OTC)
derivative instruments
• Auction rate securities
55
44
• Certain foreign government securities
Withdrawalrate
rate
Withdrawal
44
Some companies also held Level 3 investments in their separate accounts,
although these typically represented only a small portion of the assets in these
accounts.
types of Level 3 instruments held in these accounts
CompanyThe
type
Assetsincluded
Company
type
Assets
commercial mortgage loans, limited partnership interests and real estate.
Powerand
and
Power
ultilities
ultilities
57%
57%
32
Oiland
and
Oil
gas
gas
43%
43%
Lessthan
than
Less
$25billion
billion
$25
11%
11%
55
In addition, the insurance companies in our study also classified the following
Nonperformance
risk 3 measurements:
types ofNonperformance
instruments asrisk
Level
Mortalityrate
rate
Mortality
$25billion
billionto
to
$25
$100billion
billion
$100
22%
22%
Morethan
than
More
$45billion
billion
$45
43%
43%
Lessthan
than
Less
$10billion
billion
$10
28%
28%
$10billion
billionto
to
$10
$45billion
billion
$45
29%
29%
Asset managers - Level of aggregation for quantitative information
Less detailed
27%
Same as other
Level 3 disclosures
73%
Quantitative information about significant unobservable inputs
All of the insurance companies in our study disclosed the significant unobservable
inputs in tabular format. Two life insurance companies used a hybrid approach.
For example, one company disclosed all of the inputs for recurring Level 3
Company
type in a table, but separately described Assets
measurements
the quantitative inputs used for
Property
nonrecurring Level 3 items (e.g., collateral-dependent loans) in a narrative format.
$25 billion to
$100 billion
22%
and
casualty
Over in our
For certain asset classes, such asinsurance
embedded derivatives, the companies
Life
$100
billion
study
generally disclosed the same33%
types of unobservable inputs. For
example, the
insurance
67%
six insurance
companies in our study that issued guaranteed minimum benefits
67%
Less than
$25 billion
11%
(e.g., GMIB, GMAB, GMWB) disclosed fairly consistent information about the types of
inputs they used to value these instruments, as the following chart illustrates.24
Number
of insurance
companies
providing
the types
same of
types
of (GMBs)
inputs (GMBs)
Number
of insurance
companies
providing
the same
inputs
Lapse rate
5
Utilization rate
5
Nonperformance risk
5
Mortality rate
4
Withdrawal rate
4
3
Volatility
We saw more diversity in the quantitative information that insurance companies
provided for their equity-indexed instruments and Level 3 structured securities
(e.g., ABS, RMBS). For the latter, some companies provided quantitative
Company
type on the unobservable inputs related to Assets
information
prepayment rates, loss severity,
default rates and discount rates (similar to what many banks provided). However,
other insurance companies disclosed
different types of unobservable
Moreinputs
than for
Oil and
$45 billion
gas rates and illiquidity premiums.
these
instruments,
including discount
Power
and
ultilities
57%
43%
43%
For fixed income securities, the most common inputs disclosed by insurance
companies were the discount rate (or a similar measure such as market yield or
credit spread) and illiquidity premium.
24
Less than
$10 billion
28%
$10 billion to
$45 billion
29%
Companies that disclosed the annuitization rate are included under utilization rate. Notwithstanding
the similarity in the type or categories of inputs provided, it may still be difficult to compare inputs
across companies or infer trends from the data due to the unique features these contracts may have.
The new fair value disclosures
33
Valuation techniques
The insurance companies in our study generally used the same techniques to
value the same (or similar) asset classes. For example, when valuing embedded
derivatives and equity-indexed annuities, virtually all of the companies we
reviewed used an actuarial cash flow model. For fixed income securities and
structured investments, a DCF analysis was the predominant technique. Option
pricing models such as a Monte Carlo simulation or Black-Scholes model were
used to value derivative instruments.
Several insurance companies also relied on pricing information received from
third parties, such as brokers or pricing services, for determining the fair value
of certain Level 3 measurements (e.g., government securities, corporate bonds,
various asset-backed securities). Consistent with the other industries we analyzed,
the insurance companies in our study excluded these securities from their tabular
inputs disclosures, presumably because they determined the unobservable inputs
for these items were not reasonably available. One company described the types of
significant inputs that it expected brokers to use in pricing these instruments.
Valuation processes
Almost all of the insurance companies in our study provided additional
information about the valuation processes for their Level 3 measurements as
required by the ASU. Of the eight insurance companies that indicated they used
third-party pricing information as the primary source for the valuation of certain
asset classes (rather than for corroborative purposes), all disclosed, to varying
amounts of detail, the procedures they have in place to assess the reasonableness
of this information. The following points highlight the types of procedures
discussed by the insurance companies in our sample:
• Comparison of information obtained from valuation service providers or
brokers to other third-party valuation sources for selected securities
• Ongoing price validation procedures such as backtesting to actual sales
• Validation by members of management who have relevant expertise and who
are independent of those responsible for executing transactions
• Procedures for applying adjustments to third-party pricing information
• Annual due diligence of the third-party pricing services, including assessment
of vendors’ valuation qualifications, control environment and analysis of
valuation methodologies
Compared to the banks in our sample, the insurance companies we reviewed
tended to provide less information about the specific groups within the company
responsible for the valuation procedures to validate their Level 3 measurements.
In addition, limited detail was provided about how frequently pricing models were
tested and reviewed.
34
The insurance companies we reviewed disclosed, to
varying amounts of detail, their procedures to validate
pricing information received from third parties.
The new fair value disclosures
35
Company
type
Company
type
Life Life
insurance
insurance
67%67%
Assets
Assets
Property
Property
and and
casualty
casualty
insurance
insurance
33%33%
billion
$25$25
billion
to to
$100
billion
$100
billion
22%22%
OverOver
$100
billion
$100
billion
67%67%
LessLess
thanthan
billion
$25$25
billion
11%11%
Energy
Number
of insurance
companies
providing
same
types
of inputs
(GMBs)
Number
of insurance
companies
providing
the the
same
types
of inputs
(GMBs)
Lapse
Lapse
raterate
5
5
Utilization
Utilization
raterate
5
5
5
5
Scope
of companies
reviewed
Nonperformance
Nonperformance
risk risk
We reviewed
the
disclosures
Mortality
Mortality
raterate of 14 companies in the energy industry, including
companies
in
both
the
oil
and gas (O&G) and power and utilities (P&U) sectors,
Withdrawal
rate
Withdrawal
rate
as illustrated below.
Volatility
Volatility
3 3
4
4
4
4
Most are Fortune 500 companies with assets greater than $10 billion. More than 40%
hold assets in excess of $45 billion. However, our sample excluded a number of large
integrated O&G companies that did not disclose significant Level 3 measurements.
Company type
Assets
Company
type
Company
type
Power
Power
and and
ultilities
ultilities
57%57%
Assets
Assets
Oil and
Oil and
gas gas
43%43%
MoreMore
thanthan
billion
$45$45
billion
43%43%
The Level 3 positions of the energy companies in our sample included financial
and physical derivative contracts held for hedging or trading purposes. The
Level 3 financial instruments primarily consisted of over-the-counter (OTC) longdated swaps, forwards, options, basis swaps and financial transmission rights
(FTRs). These instruments are classified as Level 3 due to the lack of observable
forward rates and volatilities in the outer years. Physical contracts with longdated maturities are typically classified in Level 3 for the same reason. Further,
certain basis swaps are classified as Level 3 due to the lack of observable inputs
at certain pricing locations.
In addition, a few energy companies in our study held certain Level 3 equity and debt
investments, such as auction rate securities classified as available-for-sale or trading.
36
LessLess
thanthan
billion
$10$10
billion
28%28%
billion
$10$10
billion
to to
billion
$45$45
billion
29%29%
Quantitative information about significant unobservable inputs
All of the energy companies we reviewed provided quantitative information
about the significant unobservable inputs used in their Level 3 measurements
in a tabular format. They also generally disclosed the same types of inputs for
the same (or similar) asset classes. For example, many companies disclosed the
implied volatilities, correlations between observable and unobservable locations,
forward prices and basis differences as the significant unobservable inputs used
to value their commodity derivatives.
However, there were differences in how companies disclosed their assumptions
about forward basis curves. Some companies disclosed the forward basis-only
curve (i.e., the basis adjustments made to the forward curve), with a subset of that
group also disclosing the related hub location and the basis location. A number of
other companies disclosed the all-in forward price, without indicating how much
the observable forward price was adjusted by unobservable inputs intended to
capture basis differences.
Valuation techniques
The energy companies in our study generally used the same valuation techniques for
the same types of derivatives. The income approach was the predominant choice for
valuing physical and financial forwards and swaps, while Black-Scholes, Monte Carlo
simulations or other option pricing methods were used to price option-type contracts.
The new fair value disclosures
37
Level of aggregation
More than 70% of the energy companies in our study provided quantitative
information about their significant unobservable inputs at a greater level of
disaggregation than used in their other Level 3 disclosures, as the following chart
indicates. The rest of the companies provided the same level of aggregation as
their other fair value disclosures. None of the energy companies we reviewed
presented this information at a higher level of aggregation.
anies -Energy
Level companies —
of aggregation
for
quantitative
information
Level of
aggregation
for quantitative
information
Same as other
Level 3 disclosures
29%
More detailed
71%
For example, while many energy companies presented other fair value information
at the “commodity derivatives” level, these companies generally disclosed
information about their significant unobservable inputs at a more granular level,
either providing detail by commodity type (e.g.,
natural
More
thangas, power, oil) and/
or instrument type (e.g., options, forwards, swaps).
Although subtotals were
$10 billion
not often provided, most companies included enough
33% information for financial
billion
to
statement $1
users
to reconcile
the quantitative input disclosures to the other fair
$10 billion
value disclosures.
50%
Less than
$1 billion
17% primarily relate to
Nonrecurring fair value measurements in this sector
impairments of long-lived assets in accordance with ASC 360.25 Only a few
companies in our sample had recorded such impairments, and they generally
excluded these items from their tables of significant unobservable inputs, instead
providing the inputs in a narrative format (e.g., in their impairment footnote
disclosures). The energy companies we reviewed generally provided less detailed
disclosures for these measurements.
Nonrecurring Level 3 measurements
25
38
ASC 360, Property, Plant, and Equipment
Valuation processes
More than 75% of the energy companies in our study
described the methods used to develop and substantiate the
unobservable inputs used in their Level 3 measurements.
The majority also described the group(s) responsible for
reviewing valuations (e.g., Risk Management Group, Risk
Policy Committee) and the internal reporting procedures
they have in place for Level 3 measurements. However,
companies did not provide much detail about the frequency
and methods they used to test their pricing models, the
processes they used to analyze changes in fair values over
time or how third-party pricing information was evaluated.
Fair value hierarchy categorization of items
for which fair value is only disclosed
Most of the energy companies in our study did not provide
the hierarchy classification of financial instruments, other
than debt. For example, for their holdings in current assets
and current liabilities, including cash equivalents, these
companies often made general statements indicating
that the cost or carrying value of these instruments
approximated fair value, without explicitly providing the
hierarchy category. In contrast, companies that held longterm debt disclosed the fair value classification for these
liabilities as either Level 2 or Level 3, depending in part on
whether the interest rate on the debt was floating (Level 2)
or fixed (generally Level 3).
The new fair value disclosures
39
Real estate
Scope of companies reviewed
We reviewed the disclosures of six companies in the real estate industry,
primarily
consisting of real
investmentinformation
trusts (REITs) that invest in
es - Level
of aggregation
for estate
quantitative
mortgages (mortgage REITs) because they had the greatest number of Level 3
measurements. The new Level 3 fair value disclosures did not have a material
other because real estate
effect on many public companies in the realSame
estateasindustry
Level 3 disclosures
properties are typically carried at cost less accumulated depreciation, not at
29%
fair value (except for impairment purposes). While real estate funds typically
carry
their
real estate investments at fair value in accordance with the guidance
More
detailed
26
in ASC 946,
71% these funds are typically not public and therefore have not yet
adopted the ASU.
The composition of our real estate sample, by assets, is illustrated below.
Assets
$1 billion to
$10 billion
50%
More than
$10 billion
33%
Less than
$1 billion
17%
26
40
ASC 946, Financial Services — Investment Companies
cost less accumulated depreciation (i.e., not at fair value unless due to impairment). While real estate
funds typically carry their real estate investments at fair value in accordance with the guidance in ASC
94627, these funds are typically not public and therefore have not yet adopted the ASU.
The composition of our real estate sample, by assets, is illustrated below. Assets
$1 to $10 billion
50%
More than $10
billion
33%
Less than $1
billion
17%
Quantitative information about significant unobservable inputs
Quantitative information about significant unobservable inputs
The companies in our study disclosed different types of inputs for similar asset
The companies in our study
disclosed
different
types
of inputs
for similar
assetinformation
classes. For example,
classes.
For example,
for CMBS,
one company
disclosed
quantitative
significant
unobservable
inputs relatedabout
to default
rates, loss unobservable
severity and
for CMBS, one company about
disclosed
quantitative
information
significant
inputs
discount
rates,
while
another
disclosed
discount
rates,
capitalization
rates
and
related to default rates, loss severity and discount rates, while another disclosed discount rates,
revenue growth
rates.
capitalization rates and revenue
growth
rates.
Level of aggregation
Level of aggregation
Half of the real estate companies in our study presented all of their Level 3
Half of the insurance companies in our study presented all of their Level 3 disclosures at the same level
disclosures at the same level of aggregation. The other half presented the
of aggregation. The other
half presented the quantitative information about their significant
quantitative information about their significant unobservable inputs at a more
unobservable inputs at agranular
more granular
level of disaggregation
than
theirdisclosures.
other fairFor
value disclosures.
level of disaggregation
compared to other
fair value
For example, a number of
companies
disaggregated
the quantitative
information
about the
example,
a number
of companies disaggregated
the quantitative
information
unobservable inputs they
used
for
their
Level
3
impaired
loans
either
by
category
collateral, as
about the unobservable inputs they used for their Level 3 impaired loans or
either
by category or collateral, as illustrated below.
illustrated below.
Category or type
Collateral
Mezzanine loans
Multifamily
Whole loans
Office
Bank loans
Hotel
27
ASC 946, Financial Services — Investment Companies
The new fair value disclosures
41
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