GE 2008 Annual Report Download - page 94

92 ge 2008 annual report
notes to consolidated financial statements
Derivatives
We use closing prices for derivatives included in Level 1, which are
traded either on exchanges or liquid over-the-counter markets.
The majority of our derivatives portfolio is valued using internal
models. The models maximize the use of market observable inputs
including interest rate curves and both forward and spot prices
for currencies and commodities. Derivative assets and liabilities
included in Level 2 primarily represent interest rate swaps, cross-
currency swaps and foreign currency and commodity forward
and option contracts.
Derivative assets and liabilities included in Level 3 primarily
represent interest rate products that contain embedded option-
ality or prepayment features.
Loans
When available, we use observable market data, including pricing
on recent closed market transactions, to value loans which are
included in Level 2. When this data is unobservable, we use
valuation methodologies using current market interest rate data
adjusted for inherent credit risk, and such loans are included in
Level 3. When appropriate, loans are valued using collateral
values as a practical expedient.
Effective January 1, 2008, we adopted SFAS 159, The Fair Value
Option for Financial Assets and Financial Liabilities. Upon adoption,
we elected to report $172 million of commercial mortgage loans
at fair value in order to have them on the same accounting
basis (measured at fair value through earnings) as the derivatives
economically hedging these loans.
We receive one quote for Level 2 and Level 3 securities where
third-party quotes are used as our basis for fair value measure-
ment. As is the case with our primary pricing vendor, third-party
providers of quotes do not provide access to their proprietary
valuation models, inputs and assumptions. Accordingly, our risk
management personnel conduct internal reviews of pricing for all
such investment securities at least quarterly to ensure reason-
ableness of valuations used in our financial statements. These
reviews are designed to identify prices that appear stale, those
that have changed significantly from prior valuations, and other
anomalies that may indicate that a price may not be accurate. We
also follow established routines for reviewing and reconfirming
valuations with the pricing provider, if deemed appropriate. In
addition, the pricing vendor has an established challenge process
in place for all security valuations, which facilitates identification
and resolution of potentially erroneous prices. Based on the
information available, we believe that the fair values provided by
the brokers are consistent with the principles of SFAS 157.
Private equity investments held in investment company affili-
ates are initially valued at cost. Valuations are reviewed at the
end of each quarter utilizing available market data to determine
whether or not any fair value adjustments are necessary. Such
market data include any comparable public company trading
multiples. Unobservable inputs include company-specific funda-
mentals and other third-party transactions in that security. Our
valuation methodology for private equity investments is applied
consistently, and these investments are generally included in
Level 3.
The following table presents our assets and liabilities measured at fair value on a recurring basis at December 31, 2008. Included
in the table are investment securities of $21,967 million, primarily supporting obligations to annuitants and policyholders in our run-
off insurance operations, and $8,190 million supporting obligations to holders of guaranteed investment contracts. Such securities
are primarily investment grade. In addition, the table includes $12,642 million and $5,236 million of derivative assets and liabilities,
respectively, with highly rated counterparties, primarily used for risk management purposes. Also included are retained interests in
securitizations totaling $6,356 million.
FIN 39
December 31, 2008 (In millions) Level 1 Level 2 Level 3 netting(a) Net balance
ASSETS
Investment securities $1,158 $27,332 $12,956 $ — $41,446
Derivatives (b) — 18,911 1,142 (7,411) 12,642
Other (c) 1 288 1,105 — 1,394
Total $1,159 $46,531 $15,203 $(7,411) $55,482
LIABILITIES
Derivatives $ 2 $12,643 $ 166 $(7,575) $ 5,236
Other (d) — 1,031 — — 1,031
Total $ 2 $13,674 $ 166 $(7,575) $ 6,267
(a) FIN 39, Offsetting of Amounts Related to Certain Contracts, permits the netting of derivative receivables and derivative payables when a legally enforceable master netting
agreement exists. Included fair value adjustments related to our own and counterparty credit risk.
(b) The fair value of derivatives included an adjustment for our non-performance risk. At December 31, 2008, the adjustment for our non-performance risk was a gain of $177 million.
(c) Included private equity investments and loans designated under the fair value option.
(d) Primarily represented the liability associated with certain of our deferred incentive compensation plans accounted for in accordance with EITF Issue 97-14, Accounting for
Deferred Compensation Arrangements Where Amounts Earned Are Held in a Rabbi Trust and Invested.